Mar 15, 2022

5 min read

Money Markets for NFTs

Understanding Lending & Borrowing of NFTs as Metaverse Assets

“NFT loans aren’t loans of NFTs; they’re loans based on the value of NFTs” — Mason Nystron.

The NFT (Non-Fungible Token) market has skyrocketed in recent years.

In 2018, the sale of Non-Fungible tokens was reported at $41 million. After that, it immensely increased to $2.5 billion within the first six months of 2021. This caught many people’s eyes and made them realize how valuable NFTs could be.

NFTs gained popularity and made headlines multiple times when the auction house named Christie sold an NFT of digital art named ‘Everydays: The First 5000 Days, which was worth approximately $69.3 million. The creator’s name was Mike Winkelman, also called Beeple.

What is NFT Collateral?

NFTs are becoming an increasingly popular instrument of investments. While earlier there was little or no connection with the DeFi space, off late, some recent transactions have brought out the fact that NFTs indeed have a relevance in DeFi and especially in the field of lending and borrowing.

The idea with NFTs as a collateral is to give people with investments in NFTs a way to get some capital without having to sell their owned NFTs.

There are two distinct methods currently that enable the use of NFTs as a collateral to take out loans.

One, Loans against NFTs i.e. take a loan in some other digital assets by depositing your NFTs
Two, Loans for NFTs i.e. take a loan to buy an NFT.

Anyone who wants to borrow a loan can use his NFT assets as collateral to borrow. On the other hand, anyone who wants to lend out loans can accept NFT assets as collateral.

If the borrower successfully pays back the loan, his non-fungible token is returned. However, if he doesn’t repay the loan, the non-fungible token that he used as collateral will be assigned to the lender or follow a liquidation route.

Loans against NFT vs. Traditional Loans

If you walk through a comparison, the lending & borrowing in DeFi work in a similar manner like our traditional banking systems. You request a bank for capital needs, and in return, they demand something of value as collateral e.g. your house.

In the DeFi space too, you submit a collateral to take a loan. Except here, the loan disbursement authority in the case of DeFi is a smart contract. It’s a straightforward process that does not require any third party demanding you to go through long-form paper works.

The interest rate is also another difference between NFT backed loans and traditional bank loans. The lending interest rate on decentralized loans is higher than traditional banks.

How Does NFT Backed Loan Works?

Firstly, the lender needs to have relevant digital assets in their wallets for paying transaction fees e.g. ETH, MATIC.
To grant a loan to someone, the lender would’ve to allow the platform to give their crypto to someone who requested the loan.
The lender will get an option on the platform to browse and find out the perfect NFT collateral for them. However, finding out the worth of the NFT collateral can be subjective because of its nature.
The lender and borrower need to have a proper conversation and fix the price of the NFT. Finding someone who will pay the right price can be time-consuming because different people have a different understanding of NFTs. They may have their prices, which may not match your expectation.
Next, the borrower would also get some choices to decide the terms like the expected amount, interest rate, etc.
Once the borrower and lender have agreed on the terms, the platform will lock the NFT, and the loan will be granted to the borrower.
The loan will be originally transferred as a crypto asset to the borrower’s wallet attached on the platform.

*Business of loans with NFT as a collaterals (Source:* *Messari.io*)

The Risk of NFT Lending

● There is a fair chance that the price of the collateral NFT will rise many folds. If the borrower fails to repay the loan, then he is losing a large sum of profits.

● Synthetic shares like that of Tesla and Apple are being traded on the blockchain. So, lenders need to be wary of them when using shares of NFTs as collateral.

● Loss or theft of NFT can put the terms of loans at serious risk.

● There is an uncertainty value of most NFT projects. This makes only notable NFT projects which can be used as collateral.

Mitigating Risks of NFT Lending

● Blocking the NFT with smart contracts. This way, the lender can earn interest on their loan, and borrowers can benefit from the NFTs liquidity. Locking NFTs in a smart contract can safeguard the NFT from theft and loss.

● Bundling NFTs when applying for collateral. This way, borrowers can save themselves from high gas fees.

● Revisiting the lending terms if the collateral NFT increases in value.

Final Verdict

NFTs as collateral have emerged as a new way to deal in lending and borrowing. Now, this asset class keeps expanding and can even bring a big revolution in the financial system.

Many experts have even confessed that NFTs will not be limited to the only metaverse, visual, gaming — there will be much more fascinating uses of it.

About EasyFi

EasyFi Network is a universal layer-2 multi-chain money market protocol for digital assets with focus on liquidity sourcing & capital efficiency for structured lending in a non-custodial manner. The Protocol is currently live on Polygon, Binance Smart Chain and Ethereum.

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To learn more about $EZ and EasyFi, please go through our whitepaper and other articles on this publication.

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