Insufficient liquidity in NFTs has given rise to the NFT-Fi track, a brief overview of representative applications and development logic

Author: Tangyuan, Hive Tech

In March, Nonfungible.com released the "NFT Market Annual Report 2021," which showed that the trading volume of NFTs (Non-Fungible Tokens) reached $17.6 billion in 2021, a staggering increase of about 210 times compared to the $80 million trading volume in 2020, indicating explosive market growth.

As we entered 2022, the major event in the NFT market was the acquisition of leading projects CryptoPunks and Meebits by Yuga Labs, the parent company of Bored Ape Yacht Club (BAYC), attempting to commercialize and integrate NFTs. The subsequent release of ApeCoin (APE) reignited the somewhat cooled NFT market.

Despite the booming NFT market, the entry threshold is becoming increasingly high, with the floor prices of top NFTs often reaching dozens or even hundreds of ETH. The high capital investment has turned this market into a game for high-end players, making it extremely difficult for small-cap consumers to purchase top NFTs, leaving ordinary users as mere spectators.

In addition to the excessively high floor prices, liquidity issues also plague users. Unlike fungible tokens (such as BTC, ETH), NFTs are not as easy to trade due to their non-fungible characteristics, where the market price of each item varies. For a transaction to occur, both the seller and buyer must agree on the price; if the buyer feels the seller's price is inflated, they will not make a purchase.

The lack of liquidity in NFTs has directly led to a decline in recent trading volumes. Some on-chain developers are trying to solve this issue through decentralized finance (DeFi), leading to the emergence of the concept of NFT-Fi, which can be simply understood as "NFT financialization," allowing NFTs to leverage on-chain financial models to address their liquidity problems.

Currently, NFT-Fi mainly includes three major scenarios: NFT ownership fragmentation, NFT lending, and NFT leasing.

NFT ownership fragmentation primarily involves dividing the ownership of high-value NFT assets and issuing ERC-20 fungible tokens to enhance the liquidity of NFT assets. NFT lending refers to holders being able to borrow short-term funds by using their NFT assets as collateral without selling them, thus enjoying the benefits of holding NFTs while improving the utilization of NFT assets. NFT leasing allows holders to rent out their NFT assets to users in need to generate income.

Although these three scenarios aim to enhance the liquidity of NFTs, the varying scarcity of each NFT asset means that even NFTs from the same brand can have vastly different prices due to certain unique characteristics.

As NFT-Fi attempts to address liquidity issues, pricing different NFT assets has become a challenge, which has resulted in the NFT-Fi market not yet seeing any blockbuster applications. Some products are already in exploration, and this issue of DeFi Hive will outline some early applications of the NFT-Fi concept.

1: NFT Ownership "Fragmentation"

As non-fungible tokens, the primary characteristics of NFTs are their uniqueness and indivisibility, with the smallest trading unit being one. This can be likened to traditional artworks, such as the paintings "Mona Lisa" and "The Last Supper." Although both were created by Leonardo da Vinci, they are two distinct artworks with different values. If they were to be auctioned, they would be traded as whole pieces.

Compared to traditional artworks, NFTs not only attach to the creator's work but also represent the creator's ownership of the work, which is recorded on the blockchain and cannot be tampered with. Additionally, since NFTs originate on-chain, the division of ownership is easier to achieve than with physical art assets, eliminating the need for off-chain contract drafting, confirmation, notarization, and other processes.

So what does "NFT fragmentation" mean? It is important to clarify that it does not mean breaking the NFT artwork itself into many pieces, but rather dividing the ownership of the artwork into multiple fungible tokens. Each token holder can obtain partial ownership of the NFT asset (the artwork). Once non-fungible tokens can be converted into fungible tokens, it means they can add liquidity in the trading market, making it easier for users to exchange.

For example, if a CryptoPunks pixel avatar is divided into 100 ERC-20 standard tokens called PUNKS, then the ownership of this NFT is split into 100 parts, and each holder of PUNKS would own 1/100 of the artwork.

CryptoPunks avatar NFT asset split into 100 ERC20 Tokens

NFT fragmentation is similar to "stock splitting" in traditional financial markets, where a high-value stock is split into several lower-value shares to increase market liquidity. For instance, after Tesla's stock TSLA was split 5:1 in 2020, its price per share has now risen to around $1,000.

Now, Tesla plans to split its stock 4:1, and if successful, users would only need $250 to purchase shares. The reduction in price is beneficial for enhancing trading enthusiasm, thereby increasing stock liquidity.

Theoretically, NFT fragmentation would lower the purchase cost, benefiting consumers with smaller capital, especially those wanting to own top NFTs. Fragmented NFTs provide them with an opportunity to participate.

Representative Application

NFT Fragmentation Application Fractional.art

Fractional.art is built on the Ethereum network and allows NFT holders to lock their NFT assets in a smart contract and then issue ERC-20 tokens that signify ownership.

When one or more NFT assets are deposited into Fractional's smart contract vault (NFT Vault), the vault will safeguard the holder's NFT assets and provide ownership tokens, which are fungible ERC-20 tokens. NFT holders can decide the number of tokens issued, their symbol, minimum price, and other parameters.

Once NFT holders receive these tokens, they can dispose of them freely, such as gifting them to friends or family, pairing the tokens with ETH to form a liquidity pool, placing them in decentralized exchange (DEX) applications under an automated market maker (AMM) mechanism for user exchange, or selling them directly.

Users holding fragmented ERC-20 tokens share ownership of the NFT with the original holder. When a buyer appears, they may initiate an auction at a price equal to or higher than the floor price. Upon completion, the auction winner will receive the NFT, and the holders of partial ownership tokens will share the proceeds proportionally.

Essentially, Fractional adds a way to release NFT liquidity and is also an important means of price discovery for NFT assets. Currently, popular NFT assets are generally overpriced, with individual BAYC NFTs priced in dozens of ETH, making it difficult for small-cap users to purchase a single BAYC.

Through Fractional, some holders of BAYC NFTs can fragment ownership, making it easier for consumers to purchase or own a certain proportion of NFTs. Furthermore, the ERC-20 tokens representing ownership can be traded on DEXs, allowing the market to automatically form prices and complete NFT pricing.

For example, a Bored Ape Yacht Club NFT numbered 290 attempted fragmentation on Fractional.art, generating the FBAYC token, turning the 290#BAYC NFT into 20,806 FBAYC tokens.

Bored Ape Yacht Club NFT numbered 290 fragmentation situation

Currently, Fractional supports the fragmentation of NFTs that are all top NFT projects, including CryptoPunks, Meebits, and Bored Ape Yacht Club.

NFT Liquidity Release Platform NFTX

NFTX is a platform for releasing NFT assets and creating liquidity. Users deposit their NFT holdings into the NFTX vault and mint a fungible token, which is an ERC-20 standard vToken. These vTokens represent the value of the deposited NFTs and serve as a claim certificate for NFTs recognized by the vault, allowing users to redeem specific NFT assets from the vault.

At any time, users can use these vTokens to randomly purchase a certain NFT from the vault (usually an NFT of similar value within the same category); users who deposit NFTs can also redeem specific NFTs from the same vault by paying an additional fee.

vToken holders can become liquidity providers (LP) for vToken-ETH, earning transaction fee revenue whenever someone buys or sells an NFT.

This solution from NFTX allows users to obtain immediate liquidity for NFTs through high-liquidity vTokens, effectively breaking down the entire value of the NFT for sale, or purchasing fragmented vTokens to combine and buy a specific NFT.

For instance, a holder of a CryptoPunks NFT deposits a pixel avatar into the NFTX vault, receiving PUNKS (vToken). If the holder chooses to sell PUNKS on SushiSwap (DEX), they achieve immediate liquidity through the NFTX platform, allowing them to sell the pixel avatar NFT without waiting for a transaction on NFT trading platforms like Opensea; meanwhile, users buying PUNKS can use the token to redeem a CryptoPunks pixel avatar of equivalent value from the vault.

2: NFT Lending

Lending applications in the DeFi market serve as infrastructure and have formed a stable product system and competitive landscape. However, there has yet to be a blockbuster product in NFT lending, which remains in the early exploration stage.

NFT lending primarily refers to the deposit and borrowing of NFTs as underlying assets, where holders can use their NFTs as collateral to borrow crypto assets from platforms or lenders.

As the underlying asset for lending applications, NFTs need to possess the characteristics of "collateral." The first point is to have a "value consensus," meaning the market recognizes the value of the NFT series and has confidence in its price, ensuring it does not collapse due to price fluctuations in the short term, making lenders willing to accept this NFT as collateral.

Moreover, the collateralized NFT assets must also have liquidity, as NFTs that are valuable but lack a market can lead to difficulties in liquidation, posing potential losses for lenders.

Based on this, the underlying assets recognized by NFT lending platforms are often high-value, highly liquid blue-chip NFT projects, primarily including CryptoPunks, BAYC, and others.

The biggest challenge with using NFTs as collateral is pricing, as pricing determines the amount of crypto that can be borrowed against the NFT. However, due to the varying scarcity of each NFT, prices can differ significantly, making it essential for NFT lending applications to solve the problem of how to assess the price of NFTs as collateral.

Currently, NFT lending platforms have formed unique operational models, including "P2P" peer-to-peer models and "pool" models.

In the P2P model, NFT holders need to negotiate acceptable prices with lenders, facilitated by the lending platform. The typical process involves the holder depositing the NFT on the lending platform, specifying the desired loan amount, term, and interest rate, while lenders can browse various NFT lending information on the platform and submit their loan amounts and interest rates.

This lending process resembles an auction, where NFT holders choose an acceptable proposal from several lenders and complete the transaction. Upon loan maturity, they must repay the principal and interest to reclaim the NFT locked in the smart contract; if they fail to repay, the collateralized NFT will be transferred to the lender.

In the pool model, holders can immediately borrow funds after depositing their NFT assets into a liquidity pool, with the entire process resembling the use of platforms like Aave or Compound. This model typically employs over-collateralization of NFT assets, with the pricing of the collateralized NFTs determined by the average floor price collected from on-chain data over a period.

Representative Application

Peer-to-Peer NFT Lending Platform NFTfi

On the NFTfi platform, borrowers place their NFT assets as collateral in the market, where lenders quote offers that include the amount of borrowed funds, term, and total repayment amount upon maturity. After the borrower makes a choice, they will receive WETH or DAI from the lender.

Meanwhile, the borrower's NFT will be locked in the NFTfi smart contract until the borrower completes the agreed repayment total by the due date. If the repayment is not made, the lender will receive the borrower's NFT.

Pool-based NFT Lending Platform DropsDAO

Drops DAO is a platform that provides instant loans for image NFTs and metaverse-related NFT assets, allowing NFT assets to be used as collateral through a liquidity pool to provide loans.

NFT holders must first select a lending pool of the same category (for example, if they have a Bored Ape NFT, they would choose the BAYC lending pool) and then deposit their NFT. The collateral price is determined based on the floor price data collected by the platform's oracle. The borrowing limit for NFT holders is generally 30% of the NFT asset's floor price, and the interest paid depends on the liquidity in the pool and the supply of NFTs.

The crypto assets in the liquidity pool are injected by lenders, who can deposit mainstream crypto assets into the corresponding liquidity pool to earn interest. Currently, supported crypto assets for deposit include USDC, ETH, WBTC, and ENJ (Enjin).

MakerDAO-like NFT Lending Platform JPEG'd

JPEG'd is also a pool-based NFT lending platform but utilizes a stablecoin mechanism.

On the JPEG'd platform, NFT holders can mint stablecoin PUSd by collateralizing their NFTs. The stablecoin PUSd is pegged to the US dollar, with a value close to $1, allowing holders to exchange PUSd for other crypto assets in on-chain DeFi applications. Thus, JPEG'd resembles MakerDAO—users deposit crypto assets to mint DAI, which they can then exchange for USDT, USDC, or other crypto assets.

For example, the holder of Cryptopunks #2020 NFT deposits the NFT into the JPEG'd platform, where the platform uses the oracle Chainlink to collect floor price data for the Cryptopunks series as a reference for assessing the value of #2020 NFT, then mints stablecoin PUSd. After generating PUSd, the holder can provide liquidity for the PUSd-related liquidity pool on a DEX and earn transaction fees.

This transforms static NFT assets into income-generating products. Of course, users can also use PUSd to exchange for the assets they need, such as USDC or DAI.

3: NFT Leasing

Currently, the practical applications of NFTs include profile pictures, game assets, virtual land in the metaverse, domain names, etc. Users holding these NFT assets can use them for display, in games, or for recreation. Most NFTs have both collectible value and utility. Instead of transferring ownership, "leasing" these valuable NFTs is also a way to appreciate or monetize them. Thus, a corresponding NFT leasing market has emerged.

NFT holders can rent their NFTs to users in need to generate additional income; correspondingly, users renting NFTs can enjoy the experience of using NFTs without paying high prices to purchase them.

In the NFT leasing market, the lessor typically defines the rental price, collateral, and maximum rental period for the NFT asset. The lessee chooses the rental period and pays the collateral and rent. Currently, NFT leasing is mainly applied in on-chain gaming scenarios, with leaseable NFT assets often being game equipment, items, or characters.

For instance, in the play-to-earn game Axie Infinity, players need to purchase three "Axie" NFTs to participate. However, during the game's peak popularity, a single Axie could cost hundreds of dollars, making it a high barrier for ordinary users.

At this time, gaming guilds offering Axie rental services emerged, renting Axie NFTs to players, who pay rent to obtain the Axies and share the earnings from the game with the guild.

Representative Application

NFT Leasing Platform reNFT

reNFT primarily operates on the Ethereum network and plans to deploy on Solana, Polygon, and Avalanche chains this year. reNFT supports NFT holders in renting out their NFT assets to earn income and plans to mint off-chain assets with rental attributes as NFTs on-chain, addressing trust and security issues between lessors and lessees.

Currently, the reNFT leasing market requires collateral, where lessees must first submit NFT assets of equal value as collateral. The platform plans to gradually eliminate this collateral requirement.

On the reNFT platform, NFT artworks, virtual land NFTs, game NFTs, domain NFTs, and more can be rented to users in need. Holders can choose to rent their NFTs based on fixed prices, terms, and collateral amounts. For example, on this platform, the rental information for the domain NFT Challange.eth shows that the daily rent for a certain domain is 0.0003 WETH, with a rental period of 100 days and collateral valued at 0.5 WETH.

Challange.eth rental information

On the reNFT platform, after the lessor determines the daily rental price and maximum rental period, they can send the NFT they wish to rent to the smart contract; the lessee inputs the desired rental time, rental cost, and collateral that matches the price; finally, the reNFT platform matches the information to facilitate the transaction. Upon the expiration of the lease, the lessor's NFT and the lessee's collateral NFT will be returned to their respective accounts.

In fact, reNFT creates a market that matches NFT supply with user demand through leasing. For example, someone may own multiple domain NFTs but have no significant use for them, allowing them to release idle domain NFTs to those in need through the leasing market.

The explosion of the leasing market may still require waiting for the overall maturity of the NFT market, including the degree of idleness of NFTs held by users, gaming guilds, and project parties, as well as the clarification of rules regarding the distinction between NFT leasing and lending, which are related to market risks.