July 18, 2022
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Financialization of NFTs

Financialization of NFTs

While overall NFT sentiment is bearish and trading volumes are down, according to Blockchain analytics company Nansen, the number of first-time buyers remains roughly the same, steady at 5,000 users since March this year. Many have realized that current NFTs don’t have much utility beyond being a profile picture or an in-game asset.

Financialization could change that, and we’re seeing the first companies emerge in that niche. But let’s start with the biggest problems NFT holders are facing today.

NFT liquidity

Or better put, a lack thereof. As recently discussed, traders should take liquidity into account when they are trying to trade profitably. The same applies to those wanting to flip NFTs.

Nevertheless, if you have ever tried selling an NFT, you might have experienced long wait times or ridiculously low bids. Liquidity for NFTs is still low because consumers need time to make a purchase; many blue-chip NFTs are very expensive and not very accessible. But more importantly, it’s simply that demand isn’t keeping up with supply. If everyone wants to liquidate their NFTs in a downturn, who is left to buy them?

Even if you manage to sell, you might have to accept high slippage, meaning taking a bid well below your initial ask price. You might get frustrated with the inefficient use of capital because, so far, you can’t use your NFT for much else than to impress on Twitter.

With the Move-to-Earn hype, we’ve seen NFTs that serve as access to a game, and in the future, NFTs might be more shifting towards being useful beyond aesthetics. That might accelerate demand.

In the meantime, various projects work on financializing NFTs.

What does the Financialization of NFTs even mean?

In short, the financialization of NFTs refers to making them useful in DeFi protocols. Therefore, turning them from idle assets into something more useful to unlock the greater potential of NFTs.

A first step in bringing NFTs closer to financial use was made with the tokenization of NFTs.

Yes, you read that right. You can further tokenize one NFT.

Remember that Beeple artwork that sold for $69 million in 2021? The buyer was a fund called Metapurse. The same fund had bought 20 Beeple NFTs for more than $2 million earlier. They then launched B20, an ERC20 token allowing anyone to gain fractionalized ownership of that collection of 20 Beeple NFTs.

By tokenizing the collection, they offered lower entry points, as few can afford to spend $2 million on an NFT. Buyers would also benefit from any appreciation of the artwork. At some point, the B20 token even traded at $21, with a marketcap of over $80 million. Needless to say, with the recent downturn in the markets, B20 is far below its high, trading at $0.13.

Masterpurse’s approach might not have been the best one. Nevertheless, fractionalized ownership is an attractive proposition with DAOs like PleasrDAO using their treasury to invest and collect. And the benefit of joining such DAOs for investors is clear; they don’t just gain exposure; they also join a community.

But just owning a fractional piece of a million-dollar artwork might not be what you’re after. Maybe you want to use it in DeFi. Then read on.

NFTs in DeFi

Financializing NFTs means adding further utility. It can mean access to cash flow, content, experiences, and maybe governance voting rights.

In October 2021, a significant loan of $1.4 million was taken out by the owner of Autoglyph #488, a crypto-punk, one of those blue-chip collections.

Source

Lending

Lending against art isn’t a new idea. In the traditional art market at the end of 2019, the value of loans secured against fine art reached over 21 billion, according to Deloitte’s 2019 Art & Finance report.

What are the benefits of loans secured against an NFT for the borrower?

  • Capital Efficiency: you get access to more of your “locked” capital
  • Opportunity to hedge risks by investing the loan in other venues
  • similarly to why traders take out stablecoin loans in DeFi, it might be a tax-efficient way to pay real-life bills (NFA)

When users borrow against their NFTs, it’s a win-win situation, as it increases the economic activity of the protocol they use.

However, one big challenge with any lending secured by NFTs is:

How do you figure out the right price?

In traditional art markets, experts will inspect the art and its provenance and then appraise it.

In NFTs, we have markets that should indicate an NFT’s price. But without secondary market transactions, it’s hard to estimate what the broader market is willing to pay for digital artwork.

There is no consensus on the best way to address prices, but platforms like Upshot have started combining machine learning and crowdsourced appraisals to address the lack of cohesive pricing in NFTs.

In NFT lending, we can differentiate between different business models, namely:

  • p2p lending: borrowers get funds directly from peers, lock their NFT into a contract, and pay principal as well as interest to their creditors
  • p2p pool: this offers more immediate loans than pure p2p as it pools funds. Users can deposit their NFTs and borrow the protocol stablecoin. It comes at a high collateralization ratio; borrowers can take out 32% of the value of their collateral in stablecoin. An example of such a platform is JPEG'd. Note that they will only accept blue-chip NFTs when they launch because a strong price consensus is required for their model.
  • OTC (Over-the-Counter): This is the least crypto-native option because it requires going to an institution that will KYC the holder of the NFT and, based on their evaluation, decide to provide a loan.

Renting

Would you rent an NFT?

Maybe the first answer coming to mind is no. But then think about why people rent art in the real world? You could even go further and talk fashion. The online clothing rental market is estimated to reach $2.09 bn in 2025.

Renters might just need a particular outfit for a special occasion or a handbag to slay an important speech. 👜 For art, you can imagine similar reasons, from hosting events to museums changing up their collections.

Whatever the reasons, people are open to renting.

If you think of NFTs primarily as profile pictures renting might make little sense. But we’re moving beyond that. Major fashion brands have started creating collections that exist irl and in the Metaverse. Why not expand the online rental market to the Metaverse?

And an even bigger use case is in Gaming.

When Axie Infinity was at its peak, it cost prospective players thousands of dollars to get the pets even to start playing. This led to the creation of guilds and rental systems.

With the rise of Move-to-Earn, we are witnessing similar demand for a rental market, with Stepn’s rental function now highly anticipated by users. Renting the Sneaker NFT would allow users to participate without having to shoulder the high cost of buying it. They can use it and start earning the in-game token. Questions about the sustainability of Stepn’s business model aside, the prospect of being able to earn could draw in various NFT renters.

We’re just scratching the surface of what’s possible with NFTs. With use cases beyond pfps and Gaming, demand for NFTs and to rent them should increase.

We’re still early, and challenges remain. The most foundational ones are how to value NFTs and provide instant liquidity. Another one is the limited utility of NFTs.

And then lastly, there is always the question of how reliable and decentralized the network your NFTs exist on really is.

Once you move to rent NFTs, you want to be sure that you are getting the right NFT and that the network can’t just go down. You also would want to be able to initiate transactions yourself, without reliance on others.

The only way to achieve that is with a truly decentralized network. At Minima we’re building one. Everyone runs a full validating and constructing node. Everyone is equal to provide you with ultimate control over any NFTs you own, buy, rent or otherwise deploy.

You can learn more about Minima on our Wiki.

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