Overview of the NFTFi Track Landscape

Author: IOBC Capital

The NFT market exploded in January last year and became a hot leading area in the market throughout the year.

According to data from Dune Analytics, the weekly trading volume of the NFT market reached $6.15 billion in January this year. So far, the cumulative trading volume of the NFT market has exceeded $60 billion. During this period, a large number of popular NFTs emerged, such as Meebits, CryptoPunk, BAYC, etc. NFTs have also led the blockchain industry to achieve another breakthrough, as we can see many friends who originally did not belong to this circle have also changed to NFT avatars, indirectly confirming the popularity of the NFT market.

However, as the entire cryptocurrency market began to turn downward, the NFT market inevitably felt the impact, and trading volume and trading value began to decline rapidly.

With the contraction of the overall environment, the NFT market, which originally lacked liquidity, has cooled down rapidly, putting investors who entered earlier in a difficult position. The main reasons for the poor market liquidity are as follows:

1. High threshold. The prices of popular blue-chip NFTs in the current market are already very high, and the excessive price threshold makes ordinary investors hesitate, causing assets to only circulate among users with large amounts of capital. Losing a large base of investors inevitably leads to insufficient market liquidity;
2. Difficulty in price discovery. Currently, NFT trading mainly occurs through peer-to-peer transactions between users. Due to the non-fungible nature of NFTs, each NFT is unique, and even NFTs of the same category can have widely varying prices. The current market has not formed a good consensus on NFT pricing, especially since the current blue-chip NFTs are mainly images, and pricing is subjective, leading to significant differences in price estimates among different users. There are also no good value discovery tools in the market, making peer-to-peer transactions difficult to facilitate without fair pricing, and the matching time for transactions is usually quite long. Additionally, the pricing assessment systems for blue-chip and non-blue-chip NFTs differ significantly, making it hard to generalize.

3. Most NFTs lack practical value. After purchasing, holders mostly wait to sell at a higher price, and the lack of application scenarios makes trading difficult.

The low liquidity and difficulty in price discovery can influence each other. A lack of price consensus can affect the frequency of NFT transactions, while improving NFT liquidity can make pricing easier as transaction frequency increases. To improve the liquidity of the NFT market and activate the NFTs held by investors, the NFT finance sector has emerged.

Financialization transforms illiquid assets into securities-like products, granting them liquidity. The market is beginning to ponder whether the NFT industry can replicate the paths of traditional finance and the rise of the DeFi industry, given that we have already experienced the development of traditional finance and witnessed the emergence of the DeFi sector. How can NFT holders obtain greater value and higher capital efficiency?

In the following sections, we will briefly outline the current subdivisions of the NFTFi sector and introduce some representative projects.

Current NFTFi Sector Landscape

Image source: Fundamental Labs

The NFTFi sector is currently divided into several parts: NFT trading and aggregators, over-the-counter trading, lending, leasing, liquidity pools, liquidity providers, fragmentation, and valuation pricing.

1. Trading and Aggregators

Trading and aggregators are places where users buy and sell NFTs. This is one of the earliest fields in NFTs and currently holds the largest market share among the subdivisions, with representative products like Opensea and Looksrare. As shown in the figure below, the main NFT trading activities are concentrated on these two platforms.

Daily trading volume of NFTs on various platforms

2. Over-the-Counter Trading

Over-the-counter trading (OTC) refers to transactions conducted directly between parties without going through a third-party platform. Users can create a trading request on the platform and then wait for other traders to accept the request or negotiate. Users can also create trades targeted at specific traders to sell assets to a pre-agreed trader. Participants can negotiate transaction details through a chat section, and when they agree to proceed, both parties need to send their assets to an escrow contract, which will automatically execute the transaction without the need for third-party involvement. Representative projects in this field include Sudoswap, X2Y2, tader.xyz, etc.

Sudoswap

Sudoswap is a non-custodial trading platform with no platform trading fees, optimized gas fees, and the ability to trade both ERC-20 and ERC-721 assets simultaneously.

Users can create a swap transaction targeting a specific object (wallet address) on Sudoswap, add the assets they hold and the assets they want to swap, and then send the swap code to the trading partner to complete the exchange.

Currently, Sudo has launched an automated market maker contract focused on NFT liquidity - SudoAMM. Similar to liquidity pools on Uniswap, anyone can create NFT and ETH liquidity pools and provide liquidity with NFTs or ETH, or swap NFTs for ETH or vice versa within the pool.

3. NFT Lending

Lending products are one of the earliest and most popular types in DeFi. As a fundamental infrastructure of the financial market, lending products have a broad development prospect in the foreseeable future. NFT lending uses NFTs as collateral to obtain crypto loans through over-collateralization.

To be accepted as collateral, there needs to be a certain consensus on the value of NFTs in the market. On one hand, people must recognize that NFTs have value; on the other hand, the price of NFTs must be generally accepted in the market. For these reasons, the NFTs currently accepted as collateral are mainly blue-chip NFTs, such as CryptoPunk.

Lending businesses rely on the Loan to Value (LTV) ratio for risk control. When the value of an NFT falls below the loan value, the collateral needs to be liquidated, so the valuation of NFTs becomes the basis for collateralized lending. Currently, there are three main models for NFT lending:
1) Peer-to-peer (P2P) model;
2) Peer-to-pool model;
3) Centralized model.
Representative projects include NFTFi.com, DropsDao, Nexo, etc.

1) Peer-to-Peer (P2P)

In the peer-to-peer lending model, borrowers need to post their borrowing needs and then find a matching lender.
Currently, the interest rates in the peer-to-peer model are relatively high, around 30%-100%, with a loan-to-value ratio of about 50%, meaning that an NFT valued at 100 ETH can obtain approximately 50 ETH in funding.

The downside of this model is that the matching process between borrowers and lenders can take a long time, and when borrowers urgently need funds, lenders have significantly more bargaining power. The representative platform for the peer-to-peer model is NFTFi.com.

NFTFi.com

NFTFi.com is a lending platform launched in 2020. Borrowers can pledge their NFTs on the platform and display their borrowing needs, which mainly include the loan amount, loan term, interest rate, and the currency accepted for funding. Lenders can browse all borrowing needs on the platform and choose orders they are interested in, then negotiate the interest rate and term with the borrower before providing the loan. When the loan matures, if the borrower repays on time, the NFT returns to the borrower; if not, the NFT will be transferred to the lender.

2) Peer-to-Pool

In the peer-to-pool model, NFT holders can pledge their NFTs into an NFT pool to obtain loans. In this model, borrowers do not need to wait for a successful match with lenders, which shortens the time to obtain loans and improves capital efficiency. The peer-to-pool model typically also uses over-collateralization, with the pricing of NFTs based on the recent floor price data of that series in the market. This model heavily relies on the accuracy of NFT oracle pricing, as the pricing of NFTs determines the amount of loan that can be obtained against the pledged NFTs, directly affecting the platform's risk control.

DropsDao

DropsDao provides instant loans to borrowers through the NFT pool model.
NFT holders can pledge their NFTs into the pool of that category, with the collateral price determined by the floor price of that category collected by the platform, and then obtain loans worth about 30% of the collateral value, while needing to pay a certain interest to the platform.
Lenders can earn interest rewards from the pool by injecting mainstream crypto assets or stablecoins into the pool.

3) Centralized

Centralized NFT lending platforms mainly target institutional users, providing financial services only to large clients holding blue-chip NFTs. A representative platform is Nexo.io.

Nexo

Nexo is a centralized lending platform where users can borrow NFTs and other crypto assets or lend their crypto assets to earn interest. Nexo's NFT lending service is aimed at institutional users holding blue-chip NFTs like CryptoPunks and BAYC valued over $500,000, providing users with dedicated account managers. Approved users can receive instant loans.

4. NFT Leasing

NFT leasing allows for the retention of NFT ownership while transferring usage rights, enabling idle NFTs to generate greater value. Currently popular types of NFTs mainly include avatar images, domain names, virtual land in the metaverse, game equipment, etc. Although these categories of NFTs have poor trading liquidity due to high prices, their certain utility makes short-term leasing another optional way to realize value flow. For lessors, they can obtain liquid funds without transferring NFT ownership, while lessees can gain usage rights for a period without spending high prices to purchase. Representative projects include IQ Protocol, Double Protocol, etc.

Double Protocol

Double Protocol is a leasing protocol mainly focused on game-related NFTs.

The technical team of Double proposed Ethereum's EIP-4907 proposal, which was eventually approved and became the ERC-4907 protocol. This protocol specifies some leasing-related attributes within NFTs, such as user and leasing term. Through this protocol, the separation of NFT ownership and usage rights can be achieved, establishing a unified and reliable standard for NFT leasing. This is currently the 30th ERC standard approved on Ethereum. Before this standard was approved, there was no widely usable NFT leasing protocol on Ethereum, and leasing-related businesses could only be implemented through smart contracts developed by various projects.

NFT holders can choose the NFTs they want to lease on the Double Protocol platform, set the minimum and maximum lease terms and rent, and then publish the leasing information. After selecting the lease term, the lessee pays the rent and receives a doNFT representing the usage rights of the corresponding NFT. When the lease expires, the contract automatically terminates the lessee's usage rights.

5. Liquidity Pools

Users can create NFT vaults and earn transaction fees generated from NFT trading by providing liquidity (depositing NFTs) into the vault. Representative projects include NFTX, nft20, etc.

NFTX

NFTX helps users convert illiquid NFTs into more easily tradable ERC-20 tokens. Users can deposit NFTs into NFTX's vault and receive a fungible ERC-20 vToken, which can be exchanged 1:1 for the NFTs in the vault. The exchange of NFTs is random, or users can pay an additional 5% service fee to exchange for a specific NFT.

Users who obtain vTokens can sell them on DEXs (like Uniswap, Sushiswap) to gain liquidity, or purchase vTokens in DEX liquidity pools to exchange for NFTs from the vault.

NFTX's PUNK Vault

When vTokens are traded in the liquidity pool on DEXs, they enter the price discovery phase. Since vTokens can be exchanged 1:1 for NFTs in the vault, the value of vTokens is backed by NFTs, which can also achieve the effect of aggregating NFTs of similar value. For example, if a user believes that the price of a CryptoPunk NFT is lower than the market price of PUNKs, the user is likely to deposit the NFT into the vault in exchange for PUNKs and sell them in the market. Through this trading process, the floor price of a certain type of NFT can gradually be discovered.

For collectors holding low liquidity NFTs, they can deposit NFTs into the NFT vault to earn transaction fees from the vault's NFT trading, while the vTokens obtained can be sold for stablecoins, thus activating liquidity.

6. Liquidity Providers

Decentralized NFT market-making protocols mainly collect users' NFTs and provide staking rewards to these users while providing liquidity to liquidity pools like NFTX. Representative projects include FLOOR.DAO and MetaStreet.

FLOOR.DAO

Image source: Fundamental Labs

FloorDao mainly includes three roles:

a) Creditors

Users who provide NFTs to Floor can obtain $FLOOR tokens at a discounted price after providing their NFTs to the protocol.

b) Stakers

Stakers can earn rewards priced in $sFLOOR after staking $FLOOR into the treasury.

c) Treasury

The Floor treasury earns vault revenue by providing NFT liquidity to NFTX and transaction fees by providing token liquidity to Sushiswap, and these fees flow back into the FLOOR treasury.

7. Fragmentation

As non-fungible tokens, each NFT is unique and cannot be divided like fungible tokens, which somewhat limits the liquidity of NFTs. However, the ownership represented by NFTs can be fragmented.

Fragmentation involves creating fragments of a single NFT, dividing the ownership of the NFT into multiple parts, which can be traded as fungible tokens, for example, converting one NFT into 10,000 fungible tokens. This method improves liquidity by lowering the purchase threshold. NFT fragmentation is similar to "stock splitting" in traditional financial markets, where a high-value stock is split into several lower-value shares. Similar to the case of Robinhood fragmenting stocks, buyers do not have to purchase a whole Tesla stock but can buy multiple fragments of Tesla stocks. Representative projects include Fractional.art and Unic.ly.

Fractional.art

Fractional.art is built on the Ethereum network, supporting NFT collectors to lock their NFT assets in smart contracts and then issue ERC-20 fungible tokens. These fungible tokens represent the holders' ownership of the NFTs.

Users can set how many FT tokens to split the NFT into on Fractional and set a floor price for the deposited NFT. After depositing the NFT into the VAULT, they will receive the corresponding number of FT tokens. For example, a CryptoPunk collector can deposit a CryptoPunk #7171 into the HOODIE Vault on Fractional and receive 10,000 HOODIE tokens. Users can gift these 10,000 HOODIE tokens to others or keep them, and those holding these FT tokens own a portion of the NFT. With all these FT tokens, they can redeem the deposited NFT.

Once a liquidity pool for HOODIE and ETH is established on DEXs like Uniswap, users can sell HOODIE there.
For NFTs deposited in the vault, if a user bids above the set floor price, the NFT can be auctioned, and FT token holders will receive auction proceeds proportionally.

8. Pricing and Valuation

As mentioned above, the valuation and pricing of NFTs are crucial infrastructures for the entire NFT finance industry. Both NFT trading and lending rely on this service, and accurate pricing plays a vital role in improving the liquidity of the NFT market. A sound pricing system can shorten the time for matching buyers and sellers and promote the development of the lending market. Currently, many projects are exploring the field of NFT pricing, with the main valuation methods being as follows.

a) Oracles

In DeFi projects, oracles are an important part of the entire system's operation, and using oracles as price references has become a common practice. Oracles are also widely used in the NFT finance field to link prices with external markets.

A well-functioning oracle requires reliable data sources and reasonable data aggregation methods. Currently, the two most used data sources in the NFT field are Opensea's API and NFTX's floor price. Opensea, as the most commonly used trading platform in the NFT field, has significant reference value for its prices; however, the way sellers bid on Opensea also creates some room for price manipulation. The floor price discovery mechanism of NFTX, as mentioned above, relies on a similar aggregation mechanism, making it easier to eliminate price deviations and discover a fair floor price for a series of NFTs through arbitrage activities.

The protocol weights and aggregates prices from Opensea, NFTX, and other sources, using the final result as a pricing reference, which is a common model.

b) Machine Learning

Some protocols use machine learning algorithms to build models, using past trading data as input for valuation predictions. Representative projects include NFTbank, UPShot, and Banksea.

Similar to oracles, machine learning processes input metadata to derive results. The difference is that machine learning algorithms need to define the characteristics of NFTs first, group them based on these characteristics, and then process the price data of different groups of NFTs to predict the prices based on group characteristics.

Image source: Fundamental Labs

c) P2P

The P2P model discovers NFT prices through P2P lending activities.

In lending activities, both the borrower and lender need to reach a consensus on the pricing of NFTs to complete a match, so lending platforms can also act as market players.
In this market, price assessment has significant freedom and can be influenced by the borrower's urgency for funds, leading to certain price deviations. Additionally, pricing in the lending market is often final; once set, it does not change dynamically in a short period.

d) Rational Agents

The Abacus protocol determines NFT valuations through profit-maximizing rational agents.

Abacus creates a liquidity-backed valuation system. Users can create different NFT pools on Abacus and inject ETH liquidity into the pools. The value of NFTs in the pool equals the total value of ETH locked in the pool at any given time.

Conclusion

Due to the lack of liquidity in the NFT market, there has been a demand for financialization. The market has attempted and explored NFT financialization in several directions, including trading, lending, leasing, liquidity pools, and fragmentation. However, due to difficulties in valuation pricing, a lack of price consensus, and insufficient practicality, these explorations and attempts are still in their early stages.

The NFT market itself is developing and growing, achieving initial breakthroughs. Looking back at the development paths of DeFi and traditional finance, we believe that NFT finance is a sector with enormous potential. With the continuous improvement of infrastructure and industry innovation, we believe that more comprehensive solutions will emerge in the future to empower the entire NFT industry.