Can NFTfi Booster the NFT Market?
Abstract
To solve liquidity issues in the NFT space, financial applications and tools for NFT are emerging in the market. These applications and tools aim to utilize the power of finance to remedy poor liquidity and pricing issues of NFT, hence improving the efficiency of funds to create better user experiences. We define such applications and tools as NFTfi applications.
The following segments will be the focus in this article:
NFT lending and borrowing protocols provide a platform for users to stake NFT for loans as liquidity purposes. According to the different parties involved in the transactions, NFT lending and borrowing can be classified to P2P (peer to peer) and P2POOL (peer to pool). Representative projects in this segment includes: NFTfi Protocol as P2P and BendDAO as P2POOL. Solutions for NFT liquidity are fractional NFT, NFT crowd-funding protocol and NFT liquidity pool.
NFT aggregators are data aggregators for NFT. The same NFT might be priced differently across various marketplaces, and an aggregator enables a one-stop experience for purchasing, listing and selling by integrating different listings and offers from different marketplaces on a single platform. Typical projects in this segment include: Genie, Gem and ENS.vision.
NFT pricing mechanism and oracles establish a foundation for lending & borrowing and fragmentation services for NFTfi projects based on generally accepted pricing and instant pricing by oracles. Current mature solutions include Banksea and Upshot, which adopt NFT pricing estimation according to complex algorithms with multidimensional data inputs.
NFT financial derivatives are tradable financial products derived from NFT, including NFT speculation market, NFT perpetual contract, NFT options, etc. Typical projects in this segment include: Reality Cards, NFT Perp, Putty.
Overall, NFTfi is still in its early days and the projects are still in the exploratory phase. It continues to expand in the directions of liquidity improvement, price discovery mechanism and protocol layer exploring.
1. Background of NFTfi
NFT (Non-Fungible Token) has become an essential aspect in the world of crypto: it has evolved from simple PFP to an integrated unit consisting of game, metaverse, lending and borrowing, which has in turn ignited a new era of NFT + Decentralized Finance. But inherently, the indivisible nature of NFT gives rise to some drawbacks compared to FT (Fungible Token) in terms of liquidity: constraint on precision of transactions, high occupation rate of funds, lack of price discovery mechanisms, etc.
Tools and applications focusing on NFT began to emerge in the market, aimed at better improving the user experience by integrating NFT and finance so that the liquidity and pricing availability could be leveraged, therefore increasing efficiency of funds. We define such tools and applications as NFTfi applications. In this article, a thorough analysis is conducted on applicable scenarios in the NFTfi market. Based on current representative NFTfi projects, this article examines their development status and presents expectations on future trends and potential developing directions.
2. NFT Lending and Borrowing Protocol
2.1 Brief Overview of NFT Lending and Borrowing Market
Generally, the definition of NFT lending and borrowing is the action of staking ownership of NFT in collateral and receiving a corresponding loan as liquidity. Compared to Fungible Token, which possesses high liquidity and countless ways of derivation, NFT faces barriers to improving efficiency of funds due to its pricing and property aspects. Issues have emerged from time to time: complicated pricing, low liquidity, low asset turnover, etc., hatching more financial demands; lending and borrowing is a direct and convenient solution to providing liquidity.
Currently, due to the overall bearish condition of the market, NFT prices have been falling. Taking NFTfi as an example, as the asset value for collateral falls, a downward trend has begun to be spotted. According to the graph above, the number of transactions in NFTfi lending and borrowing was 2481 in April, 2321 in May and 1784 in June, and the monthly change has ranged between -6.45%, -24.76%, whereas the total valueof NFTfi loans was US$46.7 million in April, US$36.8 million in May, and US$15.8 million in June, with monthly changes of -21.2% and -57.07% respectively; the two parameters indicate a substantial downturn.
2.2 Categories of NFT Lending and Borrowing
As the other party in the transaction can be different, NFT lending and borrowing can be classified into peer to peer (P2P) and peer to pool (P2POOL).
P2P is an original method where users could complete transactions directly between each other. P2P has a comparatively larger market coverage for lending and borrowing, which provides more flexibility for NFT, but also requires a longer transaction period that lacks a price discovery direction.
For P2POOL, similar to traditional and non-fungible lending and borrowing, borrowers borrow from a fund pool, whereas lenders inject tokens to the pool and receive interest earnings and rewards. P2POOL has a comparable advantage efficiency-wise, but possible price manipulation under the price feeds mechanism adds higher risk.
2.3 Analysis of Representative NFT Lending and Borrowing Projects
NFT lending and borrowing remains in the early phase of development, and almost all projects in this segment are either P2P or P2POOL. This chapter aims to clarify the mechanism of NFT lending and borrowing by analyzing top-tier projects in the two segments, NFTfi Protocol in P2P and BendDAO in P2POOL, and provide better understanding of the overall mechanisms behind NFT lending and borrowing.
2.3.1 NFTfi — a P2P Lending and Borrowing Platform
NFTfi is a P2P lending and borrowing platform: both parties rely on the price feeds from Upshot and NFTbank; borrowers deposit NFT and lenders propose an offer on it, and the final deal terms by mutual consent is reached by both parties. Options for loan duration are available at 7/14/30/90 days, or customized. NFTfi was launched early, and its current accumulated loan volume is US$225 million with current loaning volume at US$23 million. Total number of transactions stands at 14,261.
From the data above, the average loan size is around US$10,000 with average APR at 52%, which is 4.65% monthly. The default ratio is 9.13%, and total default transactions accounts for 11.68% of total transactions. Default transactions are dense and more likely to appear in mid-small size loans with average loan duration of 33 days.
2.3.2 BendDAO- a P2POOL Lending and Borrowing Platform
BendDAO is a P2POOL lending and borrowing platform that was officially launched in March 2022. List of accepted assets as collateral is determined via votes from the community; only blue-chip NFTs, such as BAYC and CryptoPunks, etc., are accepted. The floor price is retrieved by internal oracle from OpenSea and LooksRare, and the collateral rate varies according to different assets in collateral. Meanwhile, liquidation protection is provided for 48 hours so that users can repay the loan and redeem the NFT collateral on time.
BendDAO’s current TVL is around 73,000 ETH (US$110 million), and current active loan stands at around 17,000 ETH (US$25.5 million). Interest rate is set at around 5% for lenders and 15% for borrowers; both lending and borrowing activities receive BEND as rewards.
Comparing NFTfi and BendDAO, BendDAO has seen rapid growth since its launch and attracted a large amount of blue-chip NFT for lending and borrowing.
However, the liquidity crisis hit blue-chip NFTs such as BAYC and Azuki, on BendDAO during the downturn, forcing the platform onto the edge of liquidation. Furthermore, when liquidation fears set in, users sold at a discount, which resulted in a lower floor price and hence more NFTs liquidated. In a bearish market, such mechanisms lead to lending and borrowing platforms being put on the brink of a death spiral.
2.4 Summary
The degree of prosperity on NFT lending and borrowing heavily relies on the overall market condition. Current lending and borrowing is limited to a selection of blue-chip NFTs — NFTs with mid to low prices are not widely accepted in lending and borrowing due to concerns such as high price volatility and the absence of oracles.
Despite the fact that innovations are appearing in the market for NFT lending and borrowing, the overall development is slow and still negligible compared to that of fungible tokens. Market capacity is also limited. When evaluating the value of projects in the NFT lending and borrowing space, estimated value needs to be justified at a lower level.
More financial derivatives and application scenarios are expected to appear in the current NFT lending and borrowing space. In order to achieve a large-scale NFTfi, other financial purposes apart from P2P will have to be established based on a mature pricing mechanism. As a result, NFT price oracles are prerequisites for NFTfi to develop; it will be more than difficult to see vast development in NFTfi until NFT price oracles are commonly seen in the market.
3. Solutions for Liquidity of NFT
As the crypto market shrank overall, the NFT market cooled down at even faster rate, which exposed the liquidity flaws of NFT. Blue-chip NFTs are too expensive for average investors to touch; what’s worse, NFT minted under ERC-721 have to be traded and liquidated in whole. Some distressed protocols are hence seeking new alternatives.
● Fractional NFT transforms NFT to FT with a higher degree of precision in transactions; FT are compatible for most scenarios, such as collateral, staking and leverage, etc. User experience could be improved while efficiency of funds can also be raised;
● Crowd funding lowers the threshold to entry on the demand side: users could participate and converge funds in multi-signature environments, and the NFT could be jointly managed by every participant;
● Liquidity pool provides a stable marketing making platform for users by gathering various NFTs at close to their floor prices.
●Overall, solutions to provide liquidity have sprung up as can be seen in various projects.
3.1 Fractional NFT
Fractional NFT divides an NFT into multiple pieces so that more users can share partial ownership. This is akin to sharing a whole cake by cutting it into slices.
Current NFT on the market complies ERC-721 and ERC-1155, which share a common characteristic of indivisibility. Fractional NFT will divide NFTs in the form of ERC-721 and ERC-1155 to ERC-20 tokens via smart contracts; these ERC-20 tokens carry partial ownership afterwards, and holders of these ERC-20 tokens share ownership of the NFT. After the process, these ERC-20 tokens could be utilized in many scenarios: DeFi; trade in Uniswap, participate in liquidity mining on Curve or Aave for lending and borrowing, etc., as opposed to doing nothing when lying whole in a wallet.
Furthermore, the division process is reversible. Normally, holders of fractional NFT could upload certain amounts of related ERC-20 tokens back onto a smart contract for a buy-out. When the buy-out is activated, an auction for other pieces will be initiated within a certain time range. Other holders must make decisions within this time range. If the buy-out is successful, other pieces will be returned to the original smart contract, and the one who initiated the buy-out receives the whole NFT.
In all, the fragmentation process of NFT does not lie with diving the NFT into pieces — only its ownership is divided. This is similar in the issuance of stocks, where stocks represent ownership of a company. When investors are positive about a company’s prospects, they buy its stock. Liquidity in the stock market adds to the prosperity of companies, and stock holders could benefit from this. Similarly, NFT could be viewed as a company with a certain market value in this case.
Fractional NFT has the following advantages:
➢ Higher efficiency of funds. A whole NFT has limited applications, while fractional NFT could have more interactions with DeFi protocols, such as liquidity mining, lending and borrowing, staking, etc., so that extra earnings and higher efficiency of funds is achieved;
➢ Lower barriers to enter and exit. A full NFT is rather expensive, whereas if it is shredded to parts in ERC-20, ownership is partially distributed, which lowers ownership and sale cost;
➢ More exposure. When split into pieces, an NFT could be circulated among more hands so its creator is able to receive more exposure;
➢ Price discovery. As ownership cost is reduced, more users will be able to participate in trading, which facilitates easier pricing determinants for NFT.
3.1.1 Fractional.art
Fractional.art is an exemplary project in the fractional NFT segment. An NFT vault is forged to conduct the fragmentation process and custody before a user uses the service. When the NFT is locked in the smart contract, corresponding ERC-20 tokens will be returned to holders of fractions, which are tradable on Uniswap or Sushiswap in their liquidity pools.
NFTs can be redeemed when pieces are returned in whole, or by activating an auction to purchase, often at a higher than the lowest price, which is agreed upon by the majority of holders.
The graphs above illustrate daily trading volume and cumulative vault creations, which demonstrated high popularity and traffic in early phase of launch. With the downsize of the crypto and NFT markets, demand for fractional NFT has decreased in tandem.
3.1.2 Unicly
Unicly is also a top-tier project in the fractional NFT segment, however, it supports more functions, such as AMM, liquidity mining, bidding, etc.
The fragmentation process starts from the lock of one or a series of NFT into the contract, and commensurate uToken will be returned. The integration of uToken and AMM enables exchange and liquidity mining on Unicly rather than on a third-party exchange.
During the fragmentation process, users can customize the name, symbol and total supply of the token, which is similar to building a pool on Uniswap.
As noted in the graph above, one extra parameter needs to be set by the genesis holder — the percentage of votes required so that auctions can be activated for outsiders to purchase through bidding. As shown in the graph, when 40% of uSTA is stipulated in the contract, an auction would be activated, and the highest bidder is eligible to purchase the NFT; the funds received from the purchase would be allocated to uSTA holders.
3.1.3 Summary
Fractional NFT, as a solution to liquidity issues, alleviates the issue to some extent, yet faces new emerging problems:
➢ The aforementioned two protocols share glitches in common: a vault can only be controlled by the one who creates it, but the vaults differ from each other, which means even the same NFT could have different vaults with different tokens circulating on the market;
➢ Fractional.art only supports full claims of the vault by buy-out or full collection of tokens; a single piece in the vault cannot be claimed, which adds limitations on liquidity for arbitrage activities. Issues surrounding the vote percentage setting on Unicly have been somewhat improved but the root cause has not been solved;
➢ For mid to high priced NFTs, pricing has been extremely challenging as equal valuation on fractions is unfeasible;
➢ Fungible tokens received from fragmentation also face liquidity issues.
3.2 NFT Crowdfunding Protocols
The so-called crowdfunding protocols are the protocols developed to converge funds and provide secure purchasing environment for NFT: as NFT cannot be divided, investors could diversify to minimize the risk, and enter the market with less funds.
3.2.1 Partybid
Partybid is an auction product developed by partyDAO for average investors, where anyone can start a “party” for crowdfunding purposes or join an existing “party”. When a “party” is successfully created, members can participate in reserved auctions. Before bidding, members can contribute ETH to reserve shares but these contributions cannot be withdrawn during the auction. If the NFT is to sold, the revenue will be split by members according to initial reserved shares; when not sold, the ETH will be returned to their original holders. The shares for members will be distributed in the form of ERC-20 tokens according to the “first come, first serve” rule. For example, if a jointly-owned NFT is sold at 55 ETH, and a member has already reserved shares using 50 ETH, which leaves only 5 ETH. Even if someone else deposits 10 ETH to reserve the remaining shares, he will only be able to receive the 5 ETH worth of remaining shares in reservation, and the remaining 5 ETH he deposited will be returned. The underlying logic for Partybid is similar to fractional NFT.
3.2.2 Summary
Crowdfunding is in its infancy and has not yet assembled an ecosystem on a large scale. From a glimpse of Partybid, some prominent issues need to be addressed to facilitate further development:
➢ Only NFT in ERC-721 can be purchased on Partybid; ERC-1155 is not compatible yet;
➢ It can only run on Ethereum Mainnet, not on L2;
➢ The underlying processing is through fractional.art; no proprietary fragmentation tool belongs to Partybid.
3.3 Liquidity Pool
Some investors advocate Diamond Hands: they are willing to hold certain NFT for a long period at the cost of instant liquidity. To resolve liquidity concerns arising from this matter, liquidity pools began to emerge. Liquidity pools are almost analogous to those in DeFi but users deposit NFTs with common characteristics or priced around their floor price into the same pool to mint ERC-20 tokens so that potential NFT buyers can buy the ERC-20 tokens to redeem any NFT of equivalent value in the pool. Hence, liquidity pools provide a new transaction method for those in favor of NFT in the same series and eradicate the need for auctions.
3.3.1 NFTX
NFTX is a platform aimed at creating liquidity for NFTs. Users enter an assigned vault on NFTX by depositing a certain NFT, and receive an ERC-20 token — vToken in return. A vault can be built by any one, but the right to manage will be handed over to the DAO of NFTX after construction. VToken can be used to redeem a random NFT anytime from the vault, or exchange to ETH in Swap pools, or combined with ETH for LP mining.
When vToken is traded in liquidity pools in DEX, the price discovery process starts. Meanwhile, when vToken is eligible to redeem an NFT in the vault, vToken is pegged to an NFT and valued the same. If the price of a Cryptopunk NFT is to be considered lower than that of PUNK, users are more inclined to deposit the NFT in the vault for PUNK, and sell PUNK on the market. In the transaction process, the floor price for certain NFT can be determined.
Its non-fungible nature makes NFT challenging to be priced. Vaults on NFTX exert the same effect on the NFTs when minting and redeeming, which, in fact, ultimately results in only most commonly-seen NFTs entering the vault; in other words, NFTs with floor price will be most commonly stored in the vaults. This group of NFTs is numerous, so there is a higher likelihood for liquidity generation.
3.3.2 NFT20
NFT20 is another platform designed to provide liquidity. It aims to convert NFT to ERC-20 tokens so that these tokens cam be traded on a decentralized exchange (DEX); anyone can insert NFT to corresponding pools and obtain related ERC-20 tokens. To be more specific, three interactions are achievable by users with NFT pools:
1. If an NFT is temporarily unable to be sold, it is considered illiquid. It is then eligible to enter a corresponding pool on NFT20 and receive 100 ERC-20 tokens representing this NFT in exchange; these tokens can be either traded on DEX or use for liquidity pool mining;
2. After option 1, the holder is supposed to have 100 ERC-20 tokens that represent the NFT. If the holder thinks the NFT is undervalued (i.e. he feels it is worth more 100 this tokens in this case), he or she might start a Dutch Auction for more opportunities on higher valuation;
3. If the holder desires another NFT in the same collection, he or she could complete option 1 and receive 100 ERC-20 tokens, and return these to the pool subsequently to redeem the target NFT.
3.3.3 Summary
Compared to fractional NFT, a liquidity pool is the gathering playground for NFTs at their floor price. Tokens derived from the pool have higher recognition and degree of consensus, which results in higher liquidity. However, the categories of liquidity pools are still limited, and motives for trading non-blue-chip NFTs at their floor price remain weak.
The aforementioned solutions are diverse in nature and capable of increasing funds efficiency to a certain extent. However, liquidity issues for NFT with Long Tail or rarity have yet to be solved. In the future, as the pricing mechanism can only be refined by accumulated tabulation of historical prices, liquidity for NFT will eventually improve with time.
4. NFT Transaction Aggregator
Aggregators were introduced to service the demand for NFT trading in bulk. In terms of functions, an NFT aggregator is a data aggregator for NFT: since the same NFT can be priced differently on differently marketplaces, an aggregator could integrate data from all listings and offers across different order-book trading places into one, powering one-stop buying, selling and listing. Compared to individual NFT marketplaces such as OpenSea, X2Y2, etc., an NFT aggregator holds the following advantages:
● Information is highly standardized and aggregated: users can trade single a NFT or in bulk in one platform, while being able to view relevant contents on the NFT, including trading volume, price sold, amount, blue-chip index, Diamond Hands, etc.
● Multiple payment methods add to convenience: users could pan with any tokens that are compatible with the platform (ETH/USDT/APE), and save on gas fees by packing.
4.1 Genie
Genie is an early aggregator in the market. As an avant-garde in the aggregator segment, Genie has received mass attention since launch: it was launched in a closed environment in Aug 2021 and more than 1,600 transactions were completed by 631 users with over 5,500 ETH in transaction volume. Theoretically, 40% of the gas fees paid could be saved by trading on this aggregator, but the actual savings would have depended on how many NFTs were packed in one transaction.
The following chart illustrates Genie’s trading data since its launch. From the chart, total transaction volume is 14,700 ETH, worth around US$446 million. Weekly transaction volume peaked in Dec 2021, and decreased afterwards. Trading volume on Genie has decreased since April, in accordance with bearish market conditions.
4.2 Gem
Gem is the second ranked aggregator after Genie. Compared to Genie, Gem not only possesses a more concise interface design, but also offers more info on lowest floor price, floor depth, and price measurement; the filter on Gem’s platform, on the left (Figure 12), would be familiar to users from OpenSea, the largest NFT marketplace.
From the following comparison of Gem and Genie, Gem is positioned at an absolute advantage both daily transactions and daily volume-wise.
Genie was the market’s first NFT aggregator, whereas Gem entered the market at a point where users had had time to get used to utilizing an NFT aggregator. Gem also released a better, more convenient and user-friendly product, and outmaneuvered Genie in the first battle in the aggregator market with the help of better publicity and financial support. Besides, from a gas savings perspective, Gem utilizes less gas than Genie for trading, which further cements its advantageous position.
4.3 ENS.vision: Vertical Aggregator of Transactions
Gem and Genie are universal NFT aggregators for transactions. As the NFT industry matured, aggregators for specific sectors started to emerge, notably aggregators for ENS NFT. The largest ENS NFT aggregator is ENS.vision. Connected to various marketplaces for ENS, including OpenSea and X2Y2, ENS.vision provides services for bulk registration, bulk search for expiration and registration by month or day (ENS official only supports by year). When registering in bulk, savings on transactions fees can be significant compared to the official ENS platform.
From recent trading data, total transaction volume of ENS.vision has rivaled that on OpenSea — nearly 90% of ENS transactions took place on ENS.vision. Undoubtedly, aggregators in vertical segments possess significant potential.
4.4 Summary
Competition in the NFT aggregator space will be more intense than that among exchanges: many exchanges will be able survive in the market by offering differentiated services, but the market will only need one or two convenient aggregators. The aggregator segment will be refined, and more aggregators are expected to appear in specific sectors — NFT contains significant community traits so expertise users in one particular sector will be more than likely to continue to trade in the same sector.
● Profitability When evaluating the essential three components involved in an NFT transaction — marketplace, aggregator and data analysis tools, profitability would tend to be higher the closer the component is to the money. Therefore, aggregators hold greater profitability potential as compared to data analysis tools, but rank lower than marketplaces.
● In terms of future market share, NFT transactions finished via aggregators in the past accounted for less than 5% of the total NFT market, whereas Gem itself now lays claim to 10%. Gem’s market share is expected to experience continuous growth, a sign indicative of a future major platform.
● In terms of horizontal integration, marketplaces, which possess higher profitability, have already set their sights on aggregators: OpenSea acquired GEM, while Uniswap acquired Genie. NFT data analyzing tools may be the next wave to be acquired by marketplaces.
5. NFT Pricing Mechanism and Oracles
NFT’s unique individual characteristics have made it challenging to coordinate activities across all users in the NFTfi space. In terms of TVL of NFT oracles, the only project that has amassed considerable TVL is BendDAO, with a TVL of US$95.47 million.
The issue can only be solved by adjusting the foundation-pricing. Price is the common setting of all NFTs; once the price foundation solidifies, a series of products and services can be derived from the pricing basis, such as lending and borrowing. As long as universally accepted pricing is available, with instant pricing of oracles as the base, services such as mortgaging, fragmentation, lending and borrowing, can be achieved.
5.1 Rudimentary Pricing Mechanism and Oracles
The generally adopted mechanism for NFT pricing would work by referring to individual floor prices listed on OpenSea, while some advanced mechanisms integrate data from multiple exchanges, but such methods are vulnerable to attacks and manipulations. Abacus is a maestro explorer in the NFT pricing field: Abacus has designed quoting and NFT liquidity pool as pricing tool so that precise pricing can be conducted on individual NFTs. However, it is somewhat behind machine learning-based oracles in terms of instant price feeds. Oracles are competent at generating continuous, instant and stable quotes for assets, which is friendly for the expansion of DeFi applications. Banksea and Upshot offer comparatively mature solutions via combinations of multi-dimensional data input. Differentiations in technical tracks can be observed in each project: Banksea is able to generate accurate pricing at the cost of an enormous computing workload, which makes it unfeasible for bulk pricing for a number of projects; Upshot is unable to provide as accurate pricing as Banksea as its instant quotes are tied to real market demand, but such a mechanism likely holds more promise for the future as compared to Banksea.
5.2 NFT Pricing by Game Theory
Classic Game Theory has several auction-based pricing models:
The simplest is the England Auction where the price raises with each bid, whereas the Dutch Auction model starts off with a high asking price which is lowered until it reaches a point where a participant accepts the price. Both models are widely accepted in the NFT market, and the comparative position of a fractional NFT’s price to the floor price of the original NFT decides the specific auction structure: if a fractional NFT is desired at a price lower than starting price, a Dutch Auction should be conducted, in which Abacus is a typical example.
Sealed-bid auction is another common auction method mostly adopted for bulk-buying: bid amounts submitted are sealed and the highest bid wins. A variant form of sealed-bid auction is the Vickrey Auction. In a Vickrey Auction, the highest bidder only pays the second highest bid price.
Pricing under Game Theory offers more accurate and reliable pricing results: due to the mechanism’s design and incentives of opportunists, this method ensures the accuracy of pricing so long as a sufficient number of opportunists participate. However, the cost incurred may be astounding. Moreover, the price discovery process takes time — pricing can only be completed by unceasing openings of pools in the ever-changing NFT market. To surmise, pricing under Game Theory works best for accuracy, but will never win over machine learning pricing models. The most feasible pricing model that has adopted Game Theory in the current market is Abacus.
Example:
A valuation method in Abacus is named “Competitor Incentive Valuation” and works via the following steps:
Step 1: A user initiates the valuation process and authorizes a payment for transaction fees; the payment is received as revenue to the protocol.
Step 2: Other participants submit reasonable prices, random numbers and a security deposit to the protocol.
Step 3: When the appraisal process ends, the NFT price will be calculated as the weighted sum of prices divided by total votes; the weight is decided by the percentage staked. The final price will be the result from the above calculation.
Step 4: Earnings for participants in the appraisal process is calculated. Generally, participants with appraisals within 5% of the final price will receive rewards. Therefore, the closer the appraisal price is to the final price, the more earnings will be allocated: rewards will be allocated thus: 500%, 400%, 300%, 200% and 100% for appraisals with price difference at 1%, 2%, 3%, 4%, 5%, respectively. Appraisals diverged over 5% will incur loss.
Using the above steps, Abacus employs the pricing mechanism of Game Theory — that participants are more inclined to offer the most reasonable prices in exchange for incentives. Some characteristics are worth noting in this mechanism:
1. Appraisals are accurate and reasonable. Accurate pricing is able to release a higher degree of liquidity, so staking rate could be increased from 30% to 70%.
2. Defects remain. For example, appraisers could collude and affect the final price.
3. The process is complicated, which is unfriendly for fast quotes; it is only more applicable for single item or bulk-buying.
4. Non-instant. As the market changes in seconds, instant quotes cannot be continuously provided in response to market changes.
There is still room for Game Theory to be deployed for NFT pricing, despite the fact that singular appraisals cannot solve the inefficiency issue; an ideal NFT pricing mechanism using Game Theory should be at a more mature level with higher liquidity.
5.3 NFT Oracles with Autonomous Computing
As pricing using Game Theory does not provide instant price feeds and fails to satisfy the same urgent demand from users on the market, NFT oracles with autonomous computing via machine learning play a key role in the future of NFTfi.
Generally, machine learning will extract historical data, such as sales volume, price sold/price asked, final price sold, etc., to construct a pricing prediction model. Some projects with more complex algorithms could dive deeper into specific NFT project and extrapolate the influence a specific factor plays on the price a particular NFT. For instance, the PUNK NFT will be priced while taking into account factors such as jewelry, skin color, hair style, etc. and include all NFTs on the market with such characteristics under surveillance. Any changes in such factors will be captured and reflected to the model, and the model updates the changes. This learning process will be the most significant research direction in the field since other upgrades already determine the ability to price feed instantaneously.
A current leading project in the autonomous oracles space include is Banksea. As a winning project in a Hackathon, Banksea has a large user base and receives attention from the masses; its AI model has also experienced harsh scrutiny. Although its core algorithm remains unknown, Banksea is purpoted to have the most comprehensive pricing information with the richest data input among current oracles. Apart from historical NFT data, Banksea utilizes data from the community, social media and other indirect sources, which increases the depth of its data for pricing evaluation purposes. Furthermore, a dynamic NFT white list is in effect to prevent attacks on data source.
What’s worth noting is that Banksea, utilizing Game Theory, added multi-node penalties and multiple valuation models to ensure the accuracy of pricing. Thanks to advantages of this model, Banksea developed lending and borrowing functions: the system could detect potential risks with preset risk preference options and automatically match orders. In addion, the platform charges insurance fees to prevent risk incurred by intense market fluctuation, providing cushioning for both parties so they have sufficient time to add margins. Compared to Upshot, Banksea has proven itself the more reliable platform in the market.
Preliminary progress has been achieved by oracles powered by autonomous learning; future upgrades demand more historical NFT trading data. As historical data for NFT is not abundant, evolution for this space requires more time to facilitate the accumulation of more data.
6. NFT Financial Derivatives
NFT financial derivatives stands for tradable financial products derived from NFT, including NFT prediction market, NFT perpetual contracts, NFT options, etc. As issues on liquidity and pricing remain, a higher standard has been imposed on liquidity and pricing of NFT financial derivatives. As a result, most projects in this market are still in their early phases, in terms of number of projects, and also in performance.
6.1 NFT Prediction Market: Reality Cards
Since the US Presidential Election of 2020, blockchain-based prediction markets began to be noticed; Vitalik himself published his opinions that prediction is one of the most promising applications for Ethereum. Reality cards is a product in the prediction market: bets are transformed to tradable and ownable NFT, which could produce earnings while collecting NFT cards.
Players rent NFTs to bet and predict. For example, if someone believes Real Madrid will win the UEFA Champion’s League, he or she could rent the Real Madrid NFT; if it is in the hands of someone else, a premium could be paid in order to own it. As time passes, rent will be deducted from current balance.
How would participants make profits? Assuming an event lasts for 10 days, and Gavin holds an NFT for 3 days while Vitalik holds it for 7 days. After the event ends, 30% of the final rewards will be allocated to Gavin will the rest will go to Vitalik. Rewards allocation will depend on the holding duration instead of how much rent was paid. Besides, a ranking will be provided for every single card to track duration of holding so that an NFT can be rewarded to the holder with the longest holding period.
Reality Cards creatively constructed a new product by combining NFT with bets: not only can users participate by betting on election outcomes, NFT could also be rented and owned. Reality Cards signals the potential for the future prediction market.
6.2 NFT Perpetual Contract Platform
Representative NFT Perp
NFT Perp is an NFT perpetual contract product based on floor price of blue-chip NFT. It is deployed on Arbitrum and adopts the vAMM mechanism. It remains in test phase; the official version has not yet been launched, but test tokens can be obtained for trial.
The lack of development for NFT oracles is a key issue for NFT financial derivatives. NFT Perp’s solution is to integrate pricing from Upshot, Banksea, NFTBank.ai and DROPS into the pricing from Chainlink, with TWAP (Time weighted average price) added to eliminate noise and minimize short-term fluctuations.
Similar to most perpetual contracts, NFT Perp employs a dynamic transaction fee scheme and funding rate mechanism to peg the contract price to spot. In other words, when a positive premium is increasing, transaction fees for users with long positions will increase, and transaction fees for short positions will decrease.
Representative project — Injective
Crypto derivatives exchange, Injective Pro, launched perpetual contracts based on the floor price for BAYC (Bored Ape Yacht Club) in April 2022. Retail users could trade according to the floor price of an NFT collection without actually holding the NFT; margins can be created by low, single-digit amounts.
Perpetual contracts of BAYC floor price on Injective is one of the earliest NFT perpetual contracts, and a valuable benchmark for future development of NFFT perpetual contracts; NFT Perp is a complete decentralized platform for perpetual contract, and it is likely to become the leading project in this space. NFT perpetual contracts offers hedging opportunities for NFT traders, and a low threshold for investors to participate in the growth of blue-chip NFTs.
6.3 NFT Options Platform: Putty
Putty is an NFT options platform to hedge NFT risks. V1 has already been launched, and Beta for V2 was launched on June 30 2022. 22 blue-chip NFTs are on the platform.
If an investor holding BAYC#3456 expects its price will decrease to under 100 ETH, which is the minimum price he or she is willing to sell at, then he or she could create a put option at 100 ETH with option price of 3 ETH. If someone else on market is willing to sell this option, this investor could pay 3 ETH for the option. When the price of BAYC#3456 falls under 100 ETH in a month, this investor could execute the option by selling BAYC#3456 to a buyer at 100 ETH; otherwise, this investor could keep holding BAYC#3456 with only 3 ETH paid out.
Putty functions as a hedging tool for investors, with customizable settings. However, these settings are too professional for average investors to configure. In the future, the platform may consider recommendations on settings for average investors. On top of that, due to the specialty NFTs on this platform, Diamond Hands players are less likely to participate as NFTs run the risk of being lost due to price volatility.
6.4 Summary
The number of cards in active circulation at Reality Cards number in the double digits, but the platform has received hundreds of NFTs; NFT Perp is still in its test phase; daily transaction volume of BAYC floor price perpetual contracts on Injective is merely in the tens of thousands of dollars; and only a handful of Putty transactions have been seen on Ethereum and OP. All projects mentioned in this segment are still in their infancy.
Issues are mainly on two perspectives:
● The overall NFTfi space is developing, fundamental elements, such as liquidity, pricing and oracles are in need of further improvement;
● Market capacity for NFT is relatively small despite the number of participants is increasing. Overall, it is a niche market without mass recognition from general public. When the number of participants is limited, the financial derivative sector is confined, which further caps the development of the NFT financial derivatives market.
Perpetual contracts and options are relatively mature products in traditional financial markets. Even though the underlying assets have changed, their mechanism lacks innovation and appears to be the same inherently. Until the liquidity and oracle are solved , there is little chance of witnessing explosive growth in the market. Nevertheless, the NFT prediction market, represented by Reality Cards, is a rather new product that holds potential: major events like the US Presidential Election and the FIFA World Cup may drive more betting opportunities, which may attract a great number of users in a rather short time period, boosting development.
7. Challenges and Expectations
Despite the challenges faced by the NFTfi sector, opportunities lie within:
● Current NFT lending and borrowing only supports blue-chip NFTs; mediocre NFTs are off the table. Under a more developed NFT price discovery scheme, it would be possible for non-blue-chip NFTs to enter this space. Lending and borrowing activities on blue-chip NFTs are expected to increase, and the same is expected to happen on intermediate level NFTs;
● Various liquidity solutions for NFT are present in the market, which alleviates the poor liquidity of NFTs to a certain extent; these solutions remain insufficient for non-blue-chip NFTs with lower floor price, and motives to trade these remain weak. As pricing mechanism and functions are perfected along the way, liquidity will become more critical;
● In the NFT aggregator sector, industry leaders are cementing their position and gaining strength. In the future, this sector will grow alongside the whole NFT market, and a vertical integration of NFT marketplace and data analyzing tools with an NFT aggregator is on the cards. Meanwhile, more specialized aggregators, targeted specific segments, will appear in the market;
● Within the NFT financial derivatives market, requirements on liquidity and pricing remain high for some projects. Although some projects have been successfully launched, performance has been underwhelming. The overall prosperity of the NFT market and a complete NFTfi infrastructure must be in place to promote the development of the NFT financial derivatives market in the long run;
● Accurate NFT pricing capabilities are available, but cannot provide services such as instant quote or in bulk quotes; NFT oracles powered by machine learning were subsequently born. Even though current solutions can be utilized, time is needed for massive amounts of data to be processed.
In conclusion, we believe the NFTfi sector is still very much in its infancy. As improvements are made in liquidity, price discovery and internal structures of NFT protocols(i.e., rentals inside the protocol, anti-theft, duration, etc.), in addition to upgrades on components and the inclusion of smart NFT features, NFTfi will eventually reach its golden age. We look forward to exciting times ahead.
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Huobi Blockchain Application Research Institute (referred to as “Huobi Research Institute”) was established in April 2016. Since March 2018, it has been committed to comprehensively expanding the research and exploration of various fields of blockchain. As the research object, the research goal is to accelerate the research and development of blockchain technology, promote the application of blockchain industry, and promote the ecological optimization of the blockchain industry. The main research content includes industry trends, technology paths, application innovations in the blockchain field, Model exploration, etc. Based on the principles of public welfare, rigor and innovation, Huobi Research Institute will carry out extensive and in-depth cooperation with governments, enterprises, universities and other institutions through various forms to build a research platform covering the complete industrial chain of the blockchain. Industry professionals provide a solid theoretical basis and trend judgments to promote the healthy and sustainable development of the entire blockchain industry.
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