Pantera Capital Partner: Understand the "Wrapped NFT" Lending Protocol Arcade in One Article

Original Author: Paul Veradittakit, Partner at Pantera Capital

Translator: Tanker, Deep Chain Finance

Content Overview:

• In 2021, the NFT industry experienced explosive growth, with sales exceeding $41 billion. However, most of the value of NFTs is realized through simple buying and selling on exchanges. As a powerful asset class, NFTs have significant potential, and it is crucial to develop better NFT functionalities and applications in DeFi to fully explore the value in this area. Only by doing so can investors position themselves in the NFT market in a more complex and refined manner within their portfolios.
• Arcade is a newly launched DeFi project that has built a suite of applications and infrastructure to promote the growth of NFTs as a financial asset class. Recently, they launched a flagship product, an NFT lending platform using the Pawn protocol: a peer-to-peer lending protocol that allows NFT holders to unlock ERC-20 token liquidity by posting their NFTs as collateral.
• The innovation of the Pawn protocol lies in the introduction of the concept of "wrapped NFTs (wNFT)." Borrowers can combine their ERC-20 assets and NFTs in any way and package them into a token pool to mint wNFTs. These wNFTs can then be used as collateral for ERC-20 asset loans; borrowers simply need to list their loan conditions (amount, currency, term, and interest rate) and publish them on the Arcade lending platform.
• Lenders can view various loan requests from borrowers on the Arcade platform, along with their loan terms and wNFT collateral. Once a lender identifies a lending agreement they wish to fulfill, they will accept the borrower's ERC-20 token assets as collateral, issue the loan, and sign the digital loan terms. If the borrower defaults on the loan, the lender can claim the assets packaged in the wNFT. In summary, this model combines the convenience of off-chain negotiation with the robustness of on-chain settlement, providing users with an incredibly intuitive and secure experience.
• Through the Pawn protocol, borrowers can also easily apply for loan extensions, allowing them to use the loan to fund long-term positions. This process is achieved through Aave's flash loan technology; the protocol takes out a flash loan to repay the borrower's loan, issues a new loan to the borrower, and uses the proceeds from the new loan to repay the flash loan—all completed in a single block transaction.
• To date, the platform has provided over $5 million in loans through its private testing version. Arcade plans to publicly launch its platform in the coming months and aims to develop more financial functionalities around NFTs, including asset management applications and Peer-to-Pool liquidity.
• Ultimately, Arcade's goal is to release unprecedented liquidity through every loan in users' NFT portfolios, bringing NFTs more closely together with the ever-expanding DeFi space and creating a bright future.

From DeFi to NFT-Fi

For NFTs, 2021 was undoubtedly a breakthrough year—by the end of December, global NFT market sales had exceeded $41 billion. Collections like Bored Ape Yacht Club (BAYC) and NBA Top Shot have become household names, while celebrity artists like Beeple have sold their digital artworks for over $69 million. In fact, NFTs are not just the images we see; other verticals such as gaming, music, and sports merchandise are increasingly eager to integrate NFTs into their ecosystems, a trend that has driven the launch and development of projects like Royal and Axie Infinity. Overall, the demand for verifiable ownership of digital primitives surged in 2021, and the NFT ecosystem continues to capture value at an incredible pace.

However, it is regrettable that despite the significant rise in NFT value, the means for users to realize the actual value of NFTs remain very limited, and people's understanding of NFT-Fi is merely confined to trading NFTs through platforms like OpenSea and profiting from price fluctuations. In fact, as an emerging digital asset, NFTs—many of which are worth millions—offer far more value than just being financial assets. This is akin to the traditional finance sector, where the real estate industry considers not just simple buying and selling but how to generate more material value from it. We see:

• Mortgages are often traded on the secondary market;
• Property titles are typically used as collateral for large loans;
• Even medical or educational loans can be obtained through real estate and used for stock positions.

Therefore, to fully realize the value of NFTs as a financial asset class, it is essential to develop more NFT functionalities and applications in DeFi. Only then can investors position themselves in the NFT market in a more complex and refined manner within their portfolios.

What is Arcade?

Arcade is a newly launched DeFi project that has built a suite of applications and infrastructure to promote the growth of NFTs as a financial asset class. Arcade enables end users (including NFT creators, collectors, and liquidity providers) to leverage their NFTs across countless financial use cases. Nowadays, it is particularly important to develop multifunctional and highly practical primitives, as NFTs have evolved from simple digital artworks to representations of metaverse assets and ownership.

Currently, the core flagship application launched by Arcade is the Pawn protocol, a peer-to-peer lending platform that allows NFT holders to unlock ERC-20 token liquidity by posting their NFTs as collateral. The protocol has already provided over $5 million in loans through its private testing version, including a massive loan of $800,000 from a lender with an asset management scale of up to $10 billion. In the coming months, Arcade also plans to open access to the Pawn Protocol to the public and launch other features, including Peer-to-Pool liquidity, rapid loan interest payments, and asset management applications.

How to Obtain a Loan on Arcade?

Arcade's ability to support NFTs as loan collateral hinges on the concept of "wrapped NFTs (wNFT)." Generally speaking, wrapped tokens are tokens that are pegged to the price of another cryptocurrency or a basket of cryptocurrencies. For example, wrapped Bitcoin (wBTC) is an ERC-20 token pegged to the price of Bitcoin, allowing BTC holders to use their Bitcoin on Ethereum.

The Pawn protocol allows users to mint wNFTs that are value-anchored to a mix of ERC-20, ERC-721, and ERC-1155 tokens. Users log into Arcade using their MetaMask wallet and select the cryptocurrencies, stablecoins, or NFTs they wish to use as collateral from their portfolios. They can then mint wNFTs that represent "a basket of token value." Importantly, this wNFT technology provides borrowers with an extremely flexible way to collateralize loans. Moreover, since borrowers can mix and match various NFTs and ERC-20 tokens, they can obtain more loans and greater liquidity compared to other NFT liquidity protocols.

Once they have wNFTs, users can easily set loan conditions and elements to apply for loans on the Arcade platform. The relevant conditions and elements include:

• The amount they wish to borrow
• The currency they wish to borrow (any ERC-20, usually wETH or stablecoins)
• The amount they can repay (or equivalent interest rate)

Then, users digitally sign their loan terms and determine the deposit for each item they choose as collateral before publishing this loan request on the platform. Next, the selected collateral will be transferred from their wallet to a third-party custodian during the loan period. Finally, the request is submitted to Arcade's P2P market, where it will be matched with lenders who accept the specified loan terms and collateral. It is worth noting that when this loan is created, the borrower must also pay a 2% fee on the principal to the protocol.

Borrowers must repay the loan in full before the loan term ends, and the Arcade team will soon add a feature for periodic payments. Additionally, the protocol will soon introduce a feature for extending outstanding loans (effectively extending the loan term), allowing borrowers to continue using the borrowed funds without affecting their leveraged positions. All of this is accomplished through flash loans on Aave; the principle is that the protocol takes out a flash loan to repay the user's existing loan, issues a new loan to the user, and uses the proceeds from the new loan to repay the flash loan—all completed in a single block transaction. This feature is particularly useful for borrowers looking to leverage long positions using NFTs as collateral.

How Should Lenders Operate on Arcade?

Lenders can use the Arcade platform to find outstanding loan requests submitted by borrowers and accept them. Once they find a loan request they wish to accept, lenders simply select the loan, agree to transfer the loan funds from their MetaMask wallet, and digitally sign below the loan terms.

In this case, lenders achieve off-chain negotiation and on-chain settlement of the loan while being able to carefully consider the loans they wish to accept through an intuitive off-chain interface, ensuring compliance with loan terms through automated on-chain transactions. If the borrower defaults on the loan, the lender can directly take the collateral held in the Pawn protocol by the borrower.

The Team Behind the Arcade Project

Arcade is created by the NFTech team, an NFT-Fi project that develops financial tools and platforms for non-fungible assets. The team members have impressive backgrounds, with many having served Web 3 projects and companies such as BitGo, BlockFi, Sommelier Finance, and BitMEX.

Moreover, Arcade has successfully completed a $15 million Series A funding round, with investors including Pantera Capital, Castle Island Ventures, Golden Tree Asset Management, and individuals like BlockFi CEO Zac Prince and Quantstamp CEO Richard Ma.

Final Thoughts

As the application of digital verification of ownership becomes increasingly complex, NFTs will become more popular and experience significant value appreciation. However, under the current conditions of the DeFi ecosystem, the ways users can leverage the value of NFTs are very limited; in most cases, users can only realize value by buying and selling their NFTs and profiting from price fluctuations. More importantly, this very limited utility restricts both institutional and retail investors from realizing the value of NFTs in their portfolios, ultimately hindering the growth of financial assets like NFTs.

The platform provided by Arcade greatly expands the range of financial activities that NFT users (collectors, creators, and liquidity providers) can achieve through NFTs. The Pawn protocol bundles NFTs, ERC-20s, and similar products with wNFTs as loan collateral, releasing unprecedented liquidity. Furthermore, its design combines the convenience of off-chain negotiation with the robustness of on-chain settlement, providing lending users with an extraordinarily intuitive and secure experience. As the protocol is about to be publicly released and more applications around asset management and liquidity provision are developed, NFTs will become more closely integrated with the ever-expanding DeFi space. In this process, Arcade plays a pioneering role, showcasing a hopeful and feasible vision.