NFT Use Case in Decentralised Finance as Defi-Loan     

Nischal Arvind Singh, Partner,FBDA & IPBI    

Decentralized finance, commonly known as DeFi, has been growing rapidly in recent years. It refers to the use of blockchain technology to create a financial system that operates without intermediaries. One of the most popular use cases in the DEFI space is for Non-Fungible Tokens (NFTs) in DeFi   as collateral for loans.

NFTs are unique digital assets that are verified on a blockchain and can represent anything from digital art to virtual real estate. They can also be used as collateral to secure loans in DeFi, creating a new way to access funds and finance creative projects. One of the key benefits of NFT lending protocols is that they allow for a more efficient loan process. In traditional finance, the loan process can be lengthy and cumbersome, involving a large number of intermediaries and a significant amount of paperwork. In DeFi, loans can be secured with NFTs and the entire process can be automated, making it much faster and more efficient. Using NFTs as collateral is that they offer a new type of asset that can be used to secure loans in DeFi. Unlike traditional assets like stocks or real estate, NFTs are unique and can’t be replicated. This makes them ideal for use as collateral, as they can’t be easily stolen or duplicated.      

How does NFT lending work? There are three types of NFT lending in the current Market:

1. Peer-to-peer NFT lending:

NFTfi is a well-known P2P NFT lending platform that allows you to put up your NFT as collateral. By doing so, you will receive loan proposals from other users. If you choose to accept any of these offers, you will quickly receive either WETH or DAI, which is a stablecoin, from the lending user’s wallet. During the loan period, the platform will automatically place your NFT in a secure digital vault, also known as an escrow smart contract, to ensure a smooth loan process.

An example of how NFTfi operates can be seen in a real loan scenario. A person who had purchased a Bored Ape Yacht Club #8646 NFT for 0.55 ETH a year prior decided to use it as collateral for a 90-day loan. On May 7, the lender granted the NFT owner a loan of 45 WETH. By August 5th, the lender either received 48.328767 WETH, which was a 30% annual percentage rate, or the collateralized NFT if the borrower defaulted. As of this writing, two NFT appraisal platforms, Upshot and NFTBank, valued the collateralized Bored Ape NFT at 123.63564 ETH and 147.29025 ETH respectively. Lenders are charged a 5% fee on the interest earned from successful loans, but there are no fees for borrowers utilizing the platform. In the case of a loan default, no fees are charged to the lender either.

2. Peer-to-protocol NFT lending:

Peer-to-Protocol NFT lending resembles DeFi lending protocols, where native assets are borrowed directly from lenders. Peer-to-Protocol platforms require liquidity providers (LPs) to deposit tokens into pools. The borrowers can access the liquidity by transferring their NFTs into the available vaults.

NFT lending is how borrowers collateralize their NFTs for crypto coin or fiat money loans. NFT lending is a type of loan that uses NFTs as collateral, stored on the smart contract. BendDAO is a decentralized lending platform that allows users to use NFTs as collateral to secure loans. For instance, This allows artists and creators to access the funds they need to finance their projects, without having to go through traditional financial intermediaries. However, If the value of the collateral NFTs is lower than the loan, the platform will provide 48 hours for the borrower to pay the debt. Otherwise, the NFTs will be transferred to the lenders.

        The protocol had around 1,000 NFTs collateralized as of May 2022, including 273 Bored Ape Yacht Club NFTs. The platform uses Chainlink oracles —          which are bridges connecting blockchains to data streams — to get the floor price information from OpenSea, the most popular NFT trading platform.             — source https://www.coindesk.com/learn/what-is-nft-lending.

However, the platform has struggled with low liquidity and has also faced security concerns. For example, in 2020, the protocol was hacked and a significant amount of NFTs was stolen. This highlights the importance of addressing the security and liquidity challenges facing NFT lending protocols.

3. Non-fungible debt positions

Non-Fungible Debt Positions refer to the use of NFTs to represent a borrower's outstanding debt in a decentralized finance (DeFi) lending platform. In this model, the NFT acts as a representation of the debt and can be traded on decentralized exchanges or used as collateral for other loans. On the other hand, A Flash Loan is a type of DeFi loan that allows borrowers to borrow funds for a very short period of time, usually just a few seconds. Flash loans are unique in that they do not require collateral and are often used for arbitrage opportunities or to execute complex financial transactions.

 The connection between NFT Non-Fungible Debt Positions and Flash Loans lies in the use of NFTs as collateral. In some DeFi lending platforms, NFTs can be used as collateral for a flash loan, providing a new and innovative way for borrowers to access financing. This can be particularly useful for borrowers who want to quickly execute a trade or take advantage of a market opportunity.

MakerDAO platform uses its platform for collateralized debt position lending to borrow DAI against depositing ETH as collateral, called DAI loans. The MakerDAO in NFT lending allows borrowers to use blue-chip NFT like Cryptopunks and Bore ape yacht club against the synthetic stablecoin. Other than MAkerDao reNFT is one of the NFT lending platforms that provide non-fungible debt positions.(Blue Chip NFTs: Blue Chip NFTs refer to the most well-known and successful NFT collections).

4. NFT rentals

NFT Rentals refers to the act of leasing Non-Fungible Tokens for a set duration. This can be achieved through decentralized finance protocols or direct P2P transactions. The owner of the NFT rents it to another party, allowing them to utilize it for a specific purpose or showcase it in their collection.

The rental process is streamlined through the use of smart contracts on a blockchain network. The NFT owner establishes the rental agreement, including the length of the rental period, the rental fee, and any other requirements. The NFT is then transferred to the renter for the agreed-upon purpose. Once the rental period expires, the NFT is returned to its owner.

ReNFT is a highly regarded platform for NFT rental services. It operates as a P2P service, so lenders are not obligated to store their NFTs in a digital vault. Instead, they can transfer their NFTs directly to another wallet. Additionally, NFT owners have the ability to specify the rental period, granting renters access to exclusive project activities and other benefits associated with the NFT.

The rental price, collateral cost, and duration are all determined by the NFT owner, who acts as the lender in this situation. Once renters pay the agreed-upon rent and collateral, the NFTs will be transferred to them. Upon the conclusion of the rental period, the collateral will be returned to the renters.

One of the challenges with NFT rentals is ensuring the security and safe transfer of the NFTs. Since NFTs are unique assets, it can be difficult to determine the value of a rental, and there may be concerns about the NFT being lost or damaged during the rental period. Additionally, there may be disputes over the terms of the rental, such as the rental fee or the conditions of the rental. Another challenge with NFT rentals is ensuring the availability of NFTs for rent. As the NFT market continues to grow, it may become more difficult for renters to find NFTs to rent, particularly if they are looking for a specific type of NFT.

NFT rentals offer a new and innovative way to use NFTs and provide a new source of revenue for NFT owners. However, they also come with challenges, such as ensuring the security and safe transfer of NFTs and ensuring the availability of NFTs for rent. By addressing these challenges, NFT rentals have the potential to become a valuable part of the NFT ecosystem, providing a new and innovative way for NFT owners and renters to benefit from NFTs.

Challenges and growth in future:

Despite the growth and innovation in the world of Non-Fungible tokens (NFT) lending protocols, there are still several challenges that need to be addressed. Some of the most significant challenges include:

       Liquidity: One of the biggest challenges facing NFT lending protocols is ensuring adequate liquidity. NFTs are unique assets that can be difficult to                value, making it difficult to determine the amount of collateral that should be required to secure a loan. This can make it challenging to find lenders                 willing to lend, and can also lead to higher interest rates for borrowers.

Market Volatility: NFTs are a relatively new and volatile asset class, which can make it difficult to determine the value of the collateral used to secure a loan. This can lead to problems for borrowers, who may find that the value of their collateral has decreased significantly, making it difficult for them to repay their loans.

Security: Decentralized protocols can be vulnerable to hacking and other security threats. This is a major concern for NFT lending protocols, as any security breach could result in the loss of valuable assets.

Liquidity: NFTs are more illiquid assets. Most protocols let borrowers use Blue chip NFT and such NFT ticket size is high, even in some cases, it is equal to or more than the price of a yacht and real estate. That makes NFT assets illiquid. But for the same reason, the NFT lending protocol accepts Blue Chip NFT between lender and borrower.

In conclusion, NFT lending protocols have the potential to revolutionize the world of DeFi. NFTs are a promising use case in DeFi and offer a new way to access financing for creative projects. By using NFTs as collateral, DeFi lending platforms can offer a more efficient and streamlined loan process, making it easier for artists and creators to access the funds they need. As the Defi ecosystem continues to grow, we will likely see more and more use cases for NFTs in decentralized finance.

However, to reach their full potential, they need to address the challenges of liquidity, market volatility, and security. By addressing these challenges, NFT lending protocols can provide a new and innovative way to access financing for creative projects and create exciting new financial products for investors.

Reference and source:

1. https://defillama.com/protocols/NFT%20Lending
2. https://www.coindesk.com/learn/what-is-nft-lending/
3. https://www.benddao.xyz/en/