In-depth analysis of NFTX, Unicly and other NFT liquidity protocols, exploring the future of NFT financialization

Written by: Eshita Nandini & Mason Nystrom

Compiled by: The Way of DeFi

Similar to assets in DeFi, non-fungible tokens require similar foundational elements such as lending, liquidity, and asset management, which are currently being established. Additionally, while the fundamental value proposition of NFTs lies in their uniqueness, fungibility is crucial for enhancing liquidity and the financialization of NFTs.

Source: Messari's NFT Stack

Liquidity tokens have thousands of buyers and sellers, but each NFT transaction requires a buyer and a seller—indicating lower liquidity. So far, projects focused on the financialization of NFTs are attempting to make NFTs as fungible (and liquid) as possible.

Looking at Liquidity

Similar to physical collectibles (like baseball card trading), NFTs face liquidity issues, especially for projects that are not highly valued or sought after. Despite the rising NFT market, we often see that the potential of these assets remains underdeveloped. NFT trading volume has exceeded $13 billion on Ethereum alone, and as new types of assets are tokenized onto the blockchain, trading volume will continue to increase over time.

Blue-chip NFTs in the market (like Punks) have the highest liquidity, but due to their concentration and high prices, most collectors cannot access them.

NFT Liquidity Protocols

Most NFT liquidity protocols take one of two approaches. The first approach creates liquidity by facilitating the creation of liquidity pools where individuals can deposit similar NFTs and redeem them at any given time. Protocols like NFTX and NFT20 effectively become markets built on a liquidity pool of a set of assets.

The second approach, taken by Unicly and Fractional, creates fragments/shares of a single NFT that can be traded as fungible fractional tokens (e.g., 1 NFT becomes 10,000 fungible tokens). This second method promotes greater liquidity by lowering the purchase price to acquire a portion of the entire NFT, similar to how Robinhood fragments stocks, allowing individuals to buy 2 shares of a $1,000 Tesla stock instead of having to purchase 1 full share.

The top four NFT liquidity protocols are NFTX, NFT20, Unicly, and Fractional, holding nearly $80 million in total value locked (TVL).

Note that NFT20's TVL calculation may be lower as it does not account for the value of NFTs like NFTX does. Nevertheless, NFT20's total reported TVL is approximately $9 million, still trailing behind NFTX, which currently has a TVL of $15 million. Additionally, the liquidity of fragments does not consider the treasury tokens locked in the pools.

Unicly currently holds the largest market share among the four protocols, accounting for 43% of the total locked value. NFTX leads over NFT20 in liquidity pool protocols. Fractional has accumulated a considerable market share since its recent launch in late July.

NFT Liquidity Pool and Market Protocols

We will examine two main NFT liquidity pool protocols, NFTX and NFT20.

NFTX

NFTX is a market and liquidity protocol that facilitates the buying and selling of NFTs.

Collectors can deposit entire NFTs into the NFTX vault and mint fungible tokens (vTokens) that represent the value of the NFTs. At any time, collectors can use their vTokens to randomly purchase assets from the vault. Alternatively, individuals can redeem specific tokens from the same vault by paying an additional fee.

To earn fees from vault transactions, collectors must stake their vTokens in respective liquidity pools (e.g., SushiSwap). Each time an individual sells or buys an NFT, stakers earn a fee.

One feature of NFTX's model is that users can gain instant liquidity for NFTs with high vToken liquidity. For example, a BAYC owner can immediately deposit their Bored Ape into the NFTX vault and receive BAYC vTokens. However, owners can sell tokens on decentralized exchanges like SushiSwap instead of staking BAYC vTokens. If liquidity is poor, NFT owners may sell their NFTs at prices lower than those on exchanges like OpenSea; however, the ability to gain instant liquidity often justifies the lower price.

Recently, NFTX also partnered with Futureswap to provide perpetual contracts for NFTs in the NFTX vault, allowing speculators to short or long NFTX derivatives.

NFT20

NFT20 is a decentralized NFT exchange that also enables individuals to trade, sell, and swap NFTs. Similar to NFTX, NFT20 allows NFT owners to add their NFTs (like Cryptopunk) to liquidity pools, in return for which they receive fungible ERC20 tokens specific to that pool (e.g., $100 Punks tokens). Using fungible tokens (ERC20), individuals can purchase NFTs (like CryptoPunk) in the corresponding pool or sell them through exchanges like Uniswap.

Additionally, NFT ERC20 tokens can be used for LP to enter SushiSwap or Uniswap pools, increasing the liquidity of fungible tokens, thus making the underlying NFTs more liquid. Certain NFT20 liquidity pools have liquidity mining rewards in NFT20's native token MUSE.

In the existing NFT pools on NFT20, Boring Banana's Co, Cyber Kongz, Wrapped Moon Cats, and Gutter Cats account for about 50% of the total NFT value in the protocol.

Everyone Needs a MUSE

NFT20's native governance token MUSE maintains a supply of 1 million tokens, with 500,000 allocated to the community that played the Very Nifty game in September 2020. Additionally, 300,000 tokens are reserved for liquidity mining rewards. Of the remaining 200,000 tokens, 50% (100,000) are allocated to the NFT20 DAO, and the other 50% are reserved for the founding team.

Each time an NFT is deposited into the NFT20 protocol, 100 tokens are minted, with 5% of the tokens allocated to the NFT20 protocol. The NFT20 protocol sells ERC20 NFT tokens for ETH, which are then used to purchase MUSE. Finally, 50% of the purchased MUSE is allocated to MUSE stakers.

Floor Price Issues

The floor price refers to the minimum or lowest selling price of an asset in a collection and is a widely tracked metric in NFTs. In collectibles like Punks or BAYC, the floor price is often set by the least rare (least desirable characteristics) asset in the collection. Protocols like NFTX and NFT20 naturally create pools that must be entirely composed of floor price NFTs from the collectibles, as users deposit more valuable NFTs into the pools, their NFTs will be purchased and/or swapped for lower-value NFTs. For example, if someone deposits a zombie punk (the most valuable) into the Floor Punk NFTX vault, another collector will immediately purchase Floor Punk tokens to acquire the zombie punk.

NFTX attempts to mitigate the floor price issue by creating parameters within the NFTX vault that require NFTs to meet specific standards (such as traits, records, etc.). NFTX facilitates this by allowing collectors to create multiple vaults for different categories of NFTs. For instance, there is a Cryptokitty floor price vault and a Gen 0 Cryptokitty vault, where only Cryptokitties reflecting Gen 0 metadata are allowed to be added to the vault. NFT20 aims to address the floor price issue by allowing NFT sellers to create a decentralized Dutch auction within the NFT20 asset page to obtain higher amounts of ERC20 tokens for that NFT project.

NFTX vs. NFT20

While both protocols have been live for over a year, the NFTX V2 upgrade in late June has proven to be very successful in accumulating NFTs. In just a few months, NFTX has absorbed a significant amount of high-value NFTs with its top liquidity vaults composed of CryptoPunks (PUNK), HashMasks (MASK), and CryptoPhunks (PHUNK).

In contrast, NFT20 has more NFTs in its liquidity pools; however, the average value of these NFTs tends to be lower (its TVL is significantly below that of NFTX), and the growth of NFTs in this protocol has stagnated in recent months.

In the past few months, NFT20's fees have significantly decreased, while NFTX's fees have also declined but remain at 50% of their historical high in August.

Notably, all fees from the NFTX vault are borne by the vault's stakers, whereas fees from the NFT20 market are directly borne by all MUSE stakers. While there is currently no necessity for NFT financialization protocols to directly acquire fees, NFTX has a credible path to generate fees in the future.

NFT Fragmentation Protocols

Asset fragmentation is becoming increasingly common in traditional financial systems. Traditional financial assets, from real estate to art to cash flows, are creating innovative solutions to segment these asset classes to attract more buyers.

Source: Jump Capital

Although existing startups are attempting to segment assets using their proprietary networks and systems, crypto networks offer more open, liquid, and composable solutions.

Some protocols have adopted fragmented tokens, with Niftex being one of the earliest. It allows NFT owners to create "fragments" (fractions) of NFTs as fungible tokens. Niftex was recently acquired by an unknown entity, but indications suggest that a large exchange may be the acquirer. In the meantime, users can access their fragments but cannot create new ones.

Currently, there are two main protocols leading the NFT fragmentation space: Unicly and Fractional.

Unicly

Unicly is a permissionless platform that allows users to combine NFT collections and fragment them by creating uTokens. The fragments (ERC-721 and ERC-1155 tokens) of the collection can then be traded, mixed with AMM, and used for yield farming on Unicly, rather than going to third-party exchanges.

Once an NFT collection is tokenized, specific collections (e.g., uPunks, which is an ERC-20 token representing the NFT collection) are locked in Unicly's smart contracts until enough token holders of the collection choose to unlock it. Unicly's largest vault, JennyDAO, has chosen to collect and manage all their NFTs on Unicly. The uJenny token is used to govern the DAO's vault. As of now, the DAO must reach a 50% threshold to unlock the collection.

The surge in the number of fragmented NFTs aligns roughly with the peak of this year's NFT market cycle. Unicly's usage has slightly declined, partly due to the launch and popularity of its fragmentation competitor, Fractional.

UNIC Token

Unicly conducted a basic fair token launch in May, where 90% of UNIC tokens were made available to the community through liquidity mining, and 10% were reserved for the core development team. UNIC can be obtained by staking UNIC, converting it to xUNIC. Additionally, 0.05% of all trading volume on the Unicly exchange is used as fees for repurchasing UNIC. The monthly minting rate of UNIC tokens has decreased by 5% to ensure that the supply never reaches 1 million.

Fractional

Fractional allows anyone to buy, sell, and mint fragmented NFTs. An owner of an NFT or NFT collection can use Fractional to fragment their tokens. Curators essentially act as asset managers for each NFT or NFT collection being fragmented and charge fees from each auction. Collectors can create fragments of an NFT as fungible tokens, which can be combined to redeem the NFT or purchased at prices above the floor price. Any buyer can bid on an NFT or Bundle product at the floor price, which is set by the majority of fractional holders. For example, if the real-time valuation of the Art Blocks Curated Bundle is 175 ETH but the floor price is 230 ETH, the token holders of the Art Blocks bundle indicate that they will not accept any sales of the entire Bundle unless someone bids at least 230 ETH.

If fractional NFT owners want to sell the entire NFT, they first vote on the reserve price. If a buyout occurs or the ETH deposit is greater than or equal to the reserve price, the fractional owners of the NFT can redeem their fractional tokens. Currently, there are 2,277 NFTs locked on the platform.

So far, the trading volume of Fractional's fragmented tokens has exceeded $1.5 billion, which is quite impressive considering the protocol was recently launched.

Like most trades, this story is a long-tail story, with several NFT collections on Fractional accounting for a large proportion of the trading volume. Two memes—the Doge NFT and Etherrock #72—account for over $300 million in trading volume.

PartyBid is a protocol that allows anyone to initiate a "party" to collectively bid in any public auction, using Fractional's smart contracts to facilitate its bidding process. PartyBid has recently started supporting Opensea auctions, and we expect this will bring more activity to PartyBid and Fractional.

Unicly vs. Fractional

Unicly was established earlier than Fractional and still maintains more vaults and higher TVL. However, since June, Unicly's TVL has significantly decreased (by about 50%), possibly due to new players entering the space and capturing larger shares of NFTs, which often end up on Unicly. Note that the chart above checks the vaults on Fractional, which can have multiple NFTs, but the total number of NFTs locked on Fractional is still about 10% of all NFTs locked on Unicly. Similar to NFT20 and NFTX, both NFTX and Fractional have fewer NFTs, but the average NFT/collectible they hold is more valuable than their competitors.

The main difference between the two protocols lies in what users can do after obtaining their fragmented tokens. With Fractional, users can sell their tokens or take them to third-party exchanges like SushiSwap. On the other hand, Unicly is an AMM that allows users to participate in staking or yield farming with their uTokens. Although it has fewer features than Unicly, Fractional is more user-friendly, especially for new NFT users.

The World of Fragmented Tokens

Even from NFTs to fragmented, fungible tokens, there are many interesting use cases beyond DeFi that owners can participate in. Like NFTs, the system can be used for:

• Gate communities or DAOs
• Unlocking content with fractions
• Providing royalties
• In-game/PFP avatars

The ETHLisbon hackathon project, defragment.art, enables curators of fragmented vaults to create new derivative NFTs that can be minted by the fractional owners of the original NFTs. This releases utility for fragmented NFT communities and provides opportunities for collaborative building and management.

Notes on Bridging NFT Exchanges and Fragmentation Protocols

While these protocols are essentially competing for NFTs, their use is not necessarily mutually exclusive. As discussed earlier, each NFT liquidity category has a different set of functionalities that may perform better depending on user preferences for their desired goals. For example, NFTX may be more suitable for specific NFT asset categories. For instance, Sorare has issued dozens of equally valuable cards around the same player.

NFTX or NFT20 can also be used to improve the underlying pricing of NFT collections with a large number of underlying assets. Conversely, fragmenting NFTs through collections or single collections allows DAOs to create combinations of different assets (BAYC + floor Punks + non-floor Punks), potentially creating a more valuable and liquid NFT bundle.

However, it is worth noting that many of these protocols tend to converge on how they provide liquidity, creating liquidity pools for NFTs with unique value within collections of similar value (Fractional and Unicly) or single NFTs (NFTX and NFT20). But these protocols are still competing for liquidity, and liquidity will naturally aggregate across several protocols.

The Future of NFT Liquidity

As the NFT market continues to evolve and new users join, the liquidity issues surrounding NFTs need to be urgently addressed. Currently, NFT financialization is being tackled through liquidity and fragmentation protocols. As traditional asset classes are issued as NFTs, financialization protocols will become increasingly important. Furthermore, as non-fungible assets are accepted as collateral for DeFi protocols like Maker or Compound, finding alternative methods to integrate these non-fungible assets into the system has the potential to make meaningful improvements during liquidity crises.

Importantly, composability will enable these financial NFT protocols to further develop and integrate with other protocols. Fractional has already leveraged Party Bid to allow strangers to crowdfund and purchase NFTs, such as Nouns. Elsewhere, Genie aggregates between NFT20 and NFTX to provide instant liquidity for NFTs and facilitate large-volume trades. This further enables seamless NFT behavior, such as purchasing large quantities of floor NFTs from a given collection. Existing NFT liquidity protocols will have unique opportunities to benefit from new protocols, leveraging their existing functionalities and supporting new user behaviors.