Why NFTs and DeFi are Better Together
We’re at an industry flashpoint. Blockchain technology is a genie free from the bottle, and now it’s up to creatives and developers to use that technology to guide the future. Decentralized Finance (DeFi) and Non-fungible Tokens (NFTs) have been on the tip of tongues and headlines of articles. Still, they haven’t even come close to scratching the surface of their capabilities.
DeFi is moving beyond simply developer tools into robust and highly effective financial options for end-users. At the same time, NFTs are surging in popularity both as an investment tool and a signifier of commitment to a decentralized future. There are still many unknowns about both spaces, but we do know for sure that the most compelling use cases for both emerging technologies are unexplored. NFTs at their core are proof of digital ownership, and DeFi is financialized blockchain technology. At Upstate Interactive, we’re bullish on the marriage of these two technologies to take blockchain tech into practical uses for even the latest adopters. If anything in the past few paragraphs was confusing to you, check out some of the links. Those are your best chances at getting smart fast.
Use Cases
Loans
We operate in a highly financialized system. Whether you want to start a business, buy a home, or attend school, the chances are that your first step is getting approved for a loan. DeFi technology isn’t going to change that- but it can certainly make the process easier and more transparent.
Current use cases for NFTs have them posed as a collectible or “crypto art,” which can be leveraged or used as collateral to receive a loan. There are already some organizations that have been stood up to facilitate these exchanges. NFTFi is a simple, P2P exchange-based loan platform where users can borrow by posting NFTs and letting potential lenders bid using terms of repayment.
This simple, rules-based framework is a good start, but there’s a little more market-making that needs to go into it before I’d be ready to throw my hard-earned DAI at a loan collateralized with an NFT. The price or value assigned to NFTs fluctuates depending on unpredictable market factors. Unlike a fungible ERC-20 token, you cannot simply add more liquidity to keep up the value, so if the NFT is suddenly devalued, the borrower is incentivized to default on the loan.
Here is where universally agreed-upon price discovery mechanisms need to step in and peg a price range to the NFT pre-collateralization. This raises questions about centralization and market manipulation. A potential solution would be a group of price setters creating independent valuations and loan platforms using an aggregate of their findings to develop a range. Unfortunately, that framework does not exist yet.
However, NFTs do provide more unique alternatives and incentives to prospective lenders. Once an NFT is in possession of the lender, they should have the opportunity to again loan it out for exhibitions or utilize the service that the NFT unlocks. This added incentive could lower interest rates for borrowers and provide lenders with the opportunity to squeeze increased value out of their investment.
Crowdfunding and Value Retention
Perhaps the most enticing — and potentially threatening to Web2 platforms — uses for NFTs is as a financial foundation for artists, journalists, and other creatives to fund their work. Artists and influencers are reeling back their presence on typical clearnet social media platforms in favor of dark forest platforms like Discord, Telegram, and Substack, where they are not subject to the algorithmic whims of Web2. This shift coincides perfectly with the latent community-building potential of DAOs and Web3 technology.
Ask yourself, how much is an ownership stake in your favorite book, album, or designer’s portfolio worth?
The earliest example of this is John Palmer’s $ESSAY project. Minted on the ZORA protocol and published/housed on Mirror, $ESSAY broke ground on a distributed financing future. The metagoal of $ESSAY was first a proof of concept that the newsletter model isn’t the only way for a writer to self-support. The secondary goal was publishing Palmer’s fascinating long-form piece, Scissor Labels.
In just a few hours after the NFT auction went live, backers contributed enough ETH to reach Palmer’s goal, distributing $ESSAY tokens that could be traded like any other ERC-20, with the caveat that Palmer retained 35% of all tokens. At any time, he or the other backers can trade or redeem their ownership of $ESSAY for ETH — this allows him to own his work past the point of delivery and earn continuously based on the value growth of $ESSAY.
For creators, this confluence of DeFi and NFT technologies incentivizes creating thoughtful work that will hold value instead of churning out content to fulfill a quota. Allowing fans and readers to own a share in projects takes the relationship from top-down to a conversation where all parties are equally invested in success. Ask yourself, how much is an ownership stake in your favorite book, album, or designer’s portfolio worth?
Asset Improvement
The only way to ensure mass adoption of blockchain tech is to show concrete solutions to meatspace problems. We can expand on the ideas above to hone in on some more accessible uses for blockchain tech that may appeal to folks who are not avid Twitter users, traders, or speculators.
Property tokenization both as an investment tracking tool and a safe way to help build a real estate portfolio is a low impact on-ramp for non-experts. Home improvement is a straightforward case for localized tokenization of assets.
Say you were interested in making renovations to your home in preparation for sale but were wary about asking friends and family for help. Tokenization might be a perfect option to secure funding, help with cleaning, building, or other specialist expertise. Starting with an appraisal to set the value for the property (let’s call it, $HOUSE) and distributing tokens to friends or family who help use their skills and funds to materially improve the property gives all parties a vested interest in success. By cutting out interest rates in favor of ROI, the bank no longer has to play middleman. Not to mention, tokenization in the form of an NFT could mitigate the need for a legal agreement as indisputable proof of ownership for each party.
As you’ll see below, the use case that I’ve outlined above operates in a bit of a gray zone, and until rules of the road are effectively established, there is always the chance that government regulators could come knocking. For now, I would advocate for these prospective uses to happen in small groups of individuals who know each other or have geographic proximity before expanding.
Issues
Trust
Automated trust is a functional component of blockchain tech in both theory and practice, but trust needs to expand outside of an online network. Besides transaction cost, trust is one of the most significant barriers to mass adoption of blockchain tech and, more specifically, DeFi. Placing your money in the digital hands of a protocol will always bear risk, but it is the job of early adopters to show that the risk is worth decoupling from middlemen who provide less value than they extract. Projects (both real and speculative) like those outlined above could whittle down blockchain solutions’ skepticism.
Server Hosting
NFTs have a storage problem. News stories about broken links turning NFTs into 404 errors are bubbling up to the surface. Some of the heaviest criticism of NFTs are based on the potential for the rapid deterioration of the underlying asset. Smart contracts cannot host the media that an NFT provides proof of ownership for, and even with P2P distributed sharing/storage services like IPFS, a crashing hard drive could cost a fortune. Until NFTs and the smart contracts attached are engineered to pay for their own server or storage space, this problem will persist.
Regulation (The Howey Test)
The single most confounding problem to the blockchain experiment is the question of government regulation. The Howey Test- a measurement established by the US Supreme Court and enforced by the Securities and Exchange Commission, helps decide whether or not an investment is subject to government regulation. As we saw with the charges against Ripple, followed by their suspension from Coinbase, the SEC is willing to make hard decisions. $HOUSE as outlined above would walk a fine line between an “investment contract” as defined by the SEC and an unregulated profit-sharing effort. Until there are clear rules of the road from governing bodies, this environment is still the wild west with all potential gains and risks.
Upstate Interactive is a woman-owned consultancy working at the cutting edge of blockchain technology and software development, building enterprise solutions for B2B and B2C industries. Key principles of community building, business simplification, and agile workflows guide our work.
