In-depth Exploration of NFTFi: NFT Liquidity Solutions

Original Title: 《A Deep Dive into NFTFi: Solutions for NFT Liquidity》

Author: Ladder.top

Translator: Qianwen, ChainCatcher

Background Introduction

In 2021, the NFT market has been rapidly developing, with a market value increase of over $20 billion since January, proving its thriving status. During this period, more and more NFT projects have appeared in the primary market, with record sales happening every day. However, as the market cools down, liquidity for NFTs has become a major concern for NFT collectors, as the non-fungible nature of NFTs makes them not as easily refinanced as DeFi tokens.

Selling NFTs on Opensea, Looksrare, Magic Eden, and other markets may be the first choice for NFT traders to gain liquidity. However, when the market is on a downward trend, selling can be difficult; you may not be able to sell your NFT immediately and have to wait for interested buyers to accept your offer, or you may need to accept a price much lower than the market price. So the ultimate question is how to provide more liquidity for holders.

A common approach is to use DeFi tools, such as using CryptoPunk as collateral to borrow fungible tokens. Liquidity providers lend fungible tokens and earn interest from borrowers (also known as NFT holders). Therefore, NFT holders will be able to obtain liquidity without selling their NFTs. We have already seen some interesting attempts in this field, with many innovative products and applications contributing to the appreciation of the NFT market. However, even with collateralized lending and innovations regarding NFTs already present in the NFT market, liquidity remains low and requires more effective price discovery mechanisms and more immediate liquidity solutions.

Liquidity Solutions

In this article, we will analyze some major NFT liquidity solutions, including NFT collateralized lending, NFT fragmentation, NFT automated market making (AMM), and how to achieve some innovative breakthroughs in the NFT market.

NFT Collateralized Lending

This refers to borrowers providing collateral (NFTs) to lenders, with both parties agreeing on various loan terms (such as maximum loan amount, interest rate, term, and liquidation terms). The borrower (also known as the NFT holder) then receives liquidity from the lender and repays the principal and interest at the agreed time. If the borrower fails to repay during the loan period and triggers liquidation conditions, the loan will be considered in default, and the collateral will be liquidated in an agreed manner.

Disadvantages of NFT Lending

Currently, the TVL of NFT collateralized lending is very low. On one hand, this is because NFTs are still a long-tail asset, with very few eligible collateral assets and a small number of NFT holders. On the other hand, the low penetration of NFT loans is not due to insufficient market supply and demand, but rather a lack of lending protocols that can effectively match both sides of supply and demand.

Lending protocols should primarily address three issues: first, effectively matching the supply and demand of funds; second, providing secure collateral custody; and third, establishing agreed-upon collateral liquidation procedures in the event of borrower default.

Existing Peer-to-Pool and Peer-to-Peer models do not solve the first problem. Both models have relatively low aggregation efficiency due to high implicit capital costs or time costs. Although the Peer-to-Pool model allows for instant lending, some drawbacks are hard to ignore. This model heavily relies on external oracle price feedback, leading to higher implicit capital costs. In the Peer-to-Peer model, the situation is exactly the opposite. It does not rely on NFT oracles and does not have high implicit capital costs. However, the downside of this model is that the process of matching demand and supply can be time-consuming.

NFT Fragmentation

Fragmentation is another method aimed at allowing NFTs to be split into fungible token assets, making them more liquid, profitable, and productive. To achieve this, a originally non-fungible ERC-721 or ERC-1155 NFT can be divided into multiple ERC-20 tokens that collectively represent ownership of a non-fungible token (NFT). Therefore, individuals holding ERC-20 tokens own fragmented parts of the NFT.

According to users, the three main benefits of NFT fragmentation are: 1) increased market liquidity; 2) lowered barriers to holding NFTs; 3) higher NFT valuations.

Disadvantages of NFT Fragmentation

However, the side effect of fragmentation is that it often leads to more intense price volatility for NFTs. As fragmentation increases the liquidity of NFTs, more people can now buy and sell parts of NFTs in the form of ERC-20 tokens. Therefore, more speculative activities can occur, often leading to impulsive purchases or panic selling. Ultimately, fragmented NFTs may deviate from the original NFT price. Additionally, when distributing NFT airdrop revenues, fragmentation can lead to other issues, such as the airdrop conducted by Kennel and Ape tokens for BAYC holders.

NFT AMM

AMM stands for Automated Market Maker, a decentralized trading mechanism that relies on mathematical formulas for asset pricing. Unlike traditional order book markets (such as Opensea, X2Y2, and Fractal), the AMM pool mechanism uses pricing algorithms in smart contracts to automatically set asset prices, creating a liquidity pool for each NFT or collection. NFT AMM can help NFT holders instantly buy and sell swaps.

Ladder Protocol

The Ladder protocol is a decentralized NFT AMM designed to create a powerful and efficient automated market for instant NFT swap trading and better price discovery. In addition to enabling low-slippage instant trading, Ladder allows users to set limit orders when purchasing specific collectibles at published prices—this way, you can clearly know how the purchase outcome will be.

In terms of pricing mechanisms, there are different types of NFT AMMs, and Ladder utilizes the constant product (XY=K) method.

The current XYK curve allows NFT holders to add liquidity to a pool, exchange, and withdraw seamlessly. Users can pair fungible token A with NFT collection B, depositing both assets into a new or existing liquidity pool. By doing so, they will receive LP shares, representing their ownership proportion in the liquidity pool over a certain period. By providing liquidity to the NFT market, they can earn interest and protocol fees.

When NFT traders exchange in the pool, the XYK changes, the NFT price changes, and each LP's share in the pool also changes. The automated market-making mechanism controlled by smart contracts ensures that all these changes occur simultaneously, enabling instant swaps of NFTs in a smooth and easy user experience. In the future, concentrated XYK curves will be further added to the smart contracts as a new pricing curve model, allowing users to control the depth and slippage of the liquidity pool by setting concentrated parameters, thus controlling the price range of the liquidity pool.

Some Benefits of Using Ladder NFT AMM

• Enhanced Liquidity: Ladder NFT liquidity pools can provide more liquidity to the NFT market.
• Stable Floor Price: Faster liquidity means a lower likelihood of panic selling, resulting in a more stable NFT floor price.
• More Buyers: More crypto traders and DeFi users will join.
• Building NFTfi: By providing liquidity infrastructure, Ladder AMM can support more NFTfi developments.
• Easy UI/UX: Ladder's UI/UX is similar to DeFi AMMs, requiring no complex choices.

Conclusion

The NFT market needs better liquidity solutions, with various attempts and innovations related to both the past and the future.

NFT collateralized lending, similar to DeFi lending, does provide some liquidity for NFT holders, as they can obtain liquidity without selling their NFTs. However, both peer-to-pool and peer-to-peer methods add some implicit costs to NFT holders in terms of capital efficiency or time efficiency. Additionally, when it comes to borrower defaults and liquidations, these methods can have a greater price impact on collections, as we have seen in the recent BendDAO case.

On the other hand, NFT fragmentation divides non-fungible tokens into fungible token fragments, thereby increasing the liquidity of NFTs. However, due to price volatility caused by impulsive purchases or panic selling, there can often be price discrepancies between NFT fragments and the original NFTs within the same collection. Furthermore, when it comes to collectibles' dividends or airdrops, fragmented NFTs will lead to greater ownership issues.

NFT AMM, as the latest innovation in NFT liquidity solutions, addresses the above issues. NFT holders can pair their NFTs with fungible tokens and join liquidity pools, earning exchange fees and profits without sacrificing implicit capital and time efficiency. Similarly, AMM does not require NFTs to be fragmented, allowing NFT holders to still hold a complete non-fungible token in the liquidity pool.

Finally, AMM is not a competitor to collateralized lending and fragmentation. Instead, we believe that Ladder AMM can help enhance market value and can be considered as liquidity infrastructure, providing strong liquidity support to unlock many innovative possibilities for the future of NFTfi.