NFT Financialization and Commodification: New Consumption x NFT = NFG

*Original Author: Sally, * IOSG Ventures

Original Editor: Olivia, IOSG Ventures

Satoshi Nakamoto believes that Bitcoin is a self-fulfilling prophecy. By analogy, if NFTs can achieve the same synchronization of beliefs and choices as Bitcoin, we have reason to believe that the value of NFTs can be continuously reinforced in the long-term Nash equilibrium. Of course, the anchoring of beliefs and choices is fluid; currently, NFTs are far from reaching the consensus level of Bitcoin, making it naturally difficult to control or ensure this anchoring.

To address this issue means that we still need to increase the conditions supporting the Nash equilibrium equation—namely, the intrinsic value and utility of NFTs. The reasoning is quite easy to understand; as Guo Jingming once told us in his youth pain literature, "Love without material is like a pile of loose sand," which highly distills the essence of the materialist value perspective. Therefore, interest and belief are merely necessary but insufficient conditions; only when real value is enhanced will demand become rigid and choices steadfast.

It is not difficult to see that two approaches have already evolved in the market to unlock demand:

1. Step right to enhance investment attributes—NFT Financialization

2. Step left to enhance consumption attributes—NFT Commoditization

Next, we will discuss these two approaches in detail.

1. NFT Financialization: DeFi x NFT = NFT Fi

NFT financialization is not a novel topic; as early as the first half of 2021, we saw many discussions surrounding this narrative (see reports from IOSG, 1kx, Hashkey, etc.). Since NFTs themselves are a type of on-chain token standard, including protocols like ERC20, ERC721, and ERC1155, it is a very direct and robust logical chain to view them as investment products and further explore their financial attributes and derivatives. The questions then are: (1) Can NFT financialization solve demand? (2) To what extent can NFT financialization unlock the demand side for NFTs?

We believe that NFT financialization can significantly help expand and enhance demand, primarily based on the following two points:

1. Enhancing NFT consensus through DeFi integration. After combining NFTs with DeFi protocols, the barriers to entry and educational costs for participating in the NFT market can be lowered. Since the entry threshold for trading non-traditional financial instruments is relatively high, players often bear higher trading risks when lacking knowledge about these unique or exotic assets, which hinders more long-tail buyers from entering the market. A lack of sufficient trading depth and market confidence will naturally delay the accumulation of overall value consensus for NFTs.
2. Enhancing tradability and stimulating liquidity through securitization. By converting illiquid NFT assets into tradable securities, NFTs can be used as collateral like traditional securities assets, helping to slice and disperse the underlying asset pool and credit risk. With the birth and application of NFT assets and their derivative trading products, Web3 participants can diversify risks across a broader category through fractional ownership, thereby benefiting themselves.

Based on the above understanding, we believe we can first focus on the following three directions in the NFT Fi track:

• Exchanges: Establishing instant trading pairs for NFTs

• Collaterals: Using NFTs as collateral

• Derivatives: Developing NFT derivatives

A. Exchanges

A significant bottleneck of traditional order-book exchanges like Opensea and LooksRare is their inability to provide instant liquidity for NFTs, which in turn limits capital efficiency. The most straightforward and effective solution to this problem is to build instant trading pairs between NFTs (ERC-721) and fungible tokens (ETH/ERC-20).

AMM (Automated Market Maker) is undoubtedly an excellent form to realize this idea. In the past, typical fragmented NFT liquidity pool solutions like NFTX and NFT20 have successfully achieved value aggregation and averaging for collections of the same series of NFTs. However, the issue lies in that each NFT is represented by a fixed amount of fungible tokens, similar to the constant product algorithm (x*y=k) of Uniswap V2, and since NFTs and fungible tokens differ vastly in circulation, this can easily lead to insufficient market depth and high slippage.

A recently emerging upgraded AMM mechanism represented by Sudoswap has significantly improved this issue. On one hand, it allows liquidity providers (LPs) to set parameter variables delta through constant, linear, or exponential bonding curves, thus liberating degrees of freedom in pricing models and controlling the deterioration of slippage for large orders. On the other hand, unlike traditional AMMs like NFTX, Sudoswap eliminates the need to convert NFTs into ERC-20 tokens, and players can choose to set up unilateral or bilateral trading pools. Therefore, this type of bonding curve-based AMM can be considered as Uniswap V3 compared to V2.

However, the current NFT AMM mechanisms on the market still simply homogenize NFTs into fungible tokens, which largely only applies to mid- to long-tail gaming NFTs. For head NFTs with significant price differences due to distinct attributes, this is far from a satisfactory liquidity solution. Additionally, the user operation process and bonding curve settings on existing platforms are quite crude, and we hope they can add some simple step functions and data analysis interfaces for reference in the future.

B. Collaterals

Considering that the mainstream NFT lending currently relies on blue-chip profile picture NFTs, we can first use the traditional art collection lending market as a reference. Historically, the financial paradigm of obtaining loans by collateralizing art collections has long existed in traditional banking. The valuation of the art collection loan industry has already accounted for a quarter of the total value of the global art market. Deloitte and ArtTactic estimated in last year's Art & Finance report (p193-202) that the total amount of art collection collateralized loans has exceeded $24 billion, with a year-on-year growth of 10.7%. Additionally, past studies have pointed out that during economic downturns, the demand for art collection lending tends to rise based on geographical factors.

This leads to the next question: Where does this demand for collateralized lending come from?

We believe that compared to tokens, market entrants are often less willing to directly sell their blue-chip NFTs. However, holding NFTs for a long time means that a significant amount of capital is locked in illiquid assets. Therefore, on one hand, when the market environment is good, holders are likely to discover better short-term speculative opportunities, making it a good option to temporarily lend NFTs as collateral to release liquidity; on the other hand, when the economic environment is poor, holders tend to utilize the over-collateralization methods present in DeFi protocols like Compound and Aave to hold more cash while ensuring they do not lose their NFTs, thus preventing potential or sudden shortages (this also explains why the overall default rate for NFT lending is relatively low).

Generally, we can categorize the current NFT collateralized lending solutions on the market into peer-to-peer (P2P), peer-to-pool (P2Pool), collateralized debt positions (CDP), and over-the-counter (OTC) lending:

C. Derivatives

Financial derivatives are contracts or financial instruments that arise around an underlying asset. Common financial derivatives include forwards, futures, options, etc. Typically, financial derivatives possess high risk and high return characteristics and are widely used for hedging and risk diversification. For example, in real estate, buyers can go long on senior tranche CDOs without holding the underlying asset (actual property) but also face the possibility of default. For NFTs as underlying assets, we also observe that new derivative protocols are continuously emerging in the market, attempting to further activate NFT market liquidity and reduce trading costs. Simply put, we can categorize NFT financial derivatives into futures, options, insurance, and structured products.

• NFT futures solutions represented by NFTprep and NFTures can help achieve long and short trading for NFT assets and increase profit and loss leverage. However, this also raises higher requirements for price feeds from oracles and the depth of liquidity pools from market makers. Currently, most products are still in the testing phase.

• NFT options solutions represented by JpeX and Nifty allow users to hedge against floor price fluctuations of their NFTs by purchasing call or put options, thereby lowering the speculative threshold for NFTs to some extent. However, several projects are still in their early stages and face liquidity challenges.

• Insuring scarce/high-value NFTs or those representing off-chain assets is also a risk transfer method worth exploring. Considering the characteristics of NFTs, adjustments to traditional insurance models are necessary.

• Index funds established based on different NFTs or NFT products, such as Index Coop JPG, and projects like Cyan and Cedar that operate on a pay-later model, are good explorations of NFT structured products.

In past research, we have already interpreted and sorted some of the lending and derivative projects mentioned above, and more content will be further discussed in the upcoming "NFT Fi Report."

2. NFT Commoditization: New Consumption x NFT = NFG

NFT commoditization is a very interesting topic because it may signify a disruption of the entire consumer sector. However, before discussing NFT commoditization, it is necessary to first answer a question:

Can NFTs be considered traditional commodities?

Fundamentally, the existence of consumer goods is to address and soothe the widespread demands and troubles present in Maslow's hierarchy of needs. The primary purpose of people buying and consuming bulk commodities is certainly not for speculation or profit, but to utilize their unique functional value to alleviate some short-term pain. For example, we buy rice to fill our stomachs, buy cars for transportation, buy games for entertainment, and buy coffee for refreshment. Thus, conversely, when the main reason for purchasing a commercialized item is to utilize and exchange its functional attributes rather than seeking profit returns, it should be considered a consumer good.

Following the underlying logic of public consumption and combining it with the current era's context, we can make a verifiable hypothesis: if NFTs can achieve:

1. Decoupling the primary purchasing purpose from speculation

2. Mass recognition of intrinsic culture

3. Scale coverage of functional categories (assortments)

they can be nested into the narrative logic of traditional commodities and consumer goods.

If we can equate NFTs directly with traditional commodities, a thought worth exploring, though not necessarily correct, would be: to transfer the investment logic of Web2 e-commerce to the Web3 NFT marketplace sector.

Returning to the main topic, what directions does the development of NFT commoditization have? What usage scenarios can it represent?

We believe that any product possessing (1) non-complete fungibility and (2) benefiting from ownership digital certificates can be expressed in the form of NFTs. This leads to an interesting concept of Non-Fungible Goods (NFG). This narrative concept combining virtual assets with the real economy can significantly broaden the actual use value and future application scenarios of NFTs.

NFT-related commoditization use cases (Image source: @shivsakhuja)

Simply put, we can categorize NFG based on its different attributes into Private Goods and Public Goods. Private Goods can further be subdivided into Transferable and Non-Transferable/Soulbound (SBT) paradigms, while Public Goods are primarily discussed in the context of CC0/CBE (can't be evil) narratives.

1. Private Goods

• Transferable

A typical transferable NFG use case is tickets and passes.

Since concert, sports event, and other large event tickets are usually limited in quantity, and access to venues requires presenting relevant credentials for entry permission, relying on NFTs is a very suitable choice.

On one hand, NFT tickets can maximize the elimination of forgery issues, making it easier to verify ownership and authenticity of tickets; on the other hand, NFT tickets can greatly activate trading liquidity in the secondary market. In traditional Web2 secondary ticket platforms like Ticketmaster or Vividseats, market trading efficiency is relatively low, and buyers' rights are hard to guarantee. NFT tickets can help establish a standardized market that protects the rights of both parties fairly.

Moreover, by collecting historical ownership data of ticket holders on-chain, performers or organizers can consider airdropping passes, discounts, or gifts to fans in the future.

• Soulbound (SBT)

Non-transferable NFTs (SBT) can be widely used as decentralized digital identity proofs (DID) or verifiable credentials. Considering that NFTs are essentially anti-counterfeit and can be verified by anyone, issuing and holding educational certificates, skill certificates, diplomas, scores, and achievements in the form of SBT NFTs means that anyone can verify their legitimacy, thus achieving trustless verification of user identity. Protocols like Sismos, which issue SBT (ERC-1155) identity badges to users based on zk-proof technology, can complete the loop while protecting user data privacy.

Furthermore, SBT NFTs can also be used to solve the problem of verifying ballots and may potentially become a global identity standard, helping to eliminate friction and barriers caused by incompatible identity verification systems across regions.

B. Public Goods

• CC0/CME

Japanese sociologist Miura Noboru categorized the development of Japanese consumer society into four stages in "The Fourth Consumption Era," pointing out that public demand, like in the West, is undergoing an evolution from basic consumption to pursuing personalized brands and cultural consumption. This phenomenon is gradually extending to many developing countries globally. More and more people are crossing the threshold of basic consumption, with an increasing emphasis on the brand culture of products replacing the pursuit of cost-effectiveness.

The CC0 (Creative Commons Zero) agreement, which represents the author relinquishing all IP rights, undoubtedly further stimulates people's enthusiasm for the brand culture of such projects and their passion for secondary creation. Compared to the traditional privatized brand creation NFT business model, CC0 gradually evolves into an open-source "application" or "platform" with network effects by bringing products into the public domain. In the positive cycle of continuous creation and sharing of derivatives, the attention gained by the original brand and the collective consensus within the community can naturally be extended and reinforced. This also explains why, despite the significantly increased operational difficulty, many NFT projects continue to announce their shift to the CC0 model.

3. Closing Thoughts

NFT is a romantic and idealistic concept, intertwined with elements of Romain Rolland and Pablo Neruda. However, poetry cannot solve our real-world problems or provide a foundation for forming strong consensus. The development of NFTs requires more Machiavellian approaches to genuinely enhance users' marginal utility; otherwise, the advancement of NFT 2.0 may only remain in the realm of fantasy.

From Adam Smith's production-consumption theory to Alfred Marshall and Hart's "Consumer's Sovereignty," and then to Hayek's interpretation of "consumer sovereignty over producers," we see that with the development of internet technology, consumers' demands for their personal preferences are becoming increasingly strong and clear.

Eighteen years ago, Chris Anderson published the classic "Long Tail Theory" in Wired, pointing out that the reduction of attention costs in the internet age makes it possible for the personalized and decentralized long-tail demand at the tail end of the normal distribution curve to accumulate into a market larger than popular demand, and the economic benefits may even exceed those of "the hits." This means that niche products aimed at small, segmented markets may hold greater value and growth potential.

We believe that under the dual advancement of financialization and commoditization, the demand side for NFTs will achieve further leaps. Niche products like NFTs have the opportunity to unleash greater value increments in the future, genuinely changing the course of Web3 and people's lifestyles.