An analysis of the three models of NFT collateralized lending: peer-to-peer, liquidity pool, and centralized model

Original Title: "Simple Thoughts on NFT Collateralized Lending"

Original Author: Jiawei (Twitter: Elegy4TheArctic)

Source: Blockbeats

Introduction

(As time flies, the summer of DeFi in 2020 has passed for more than ten months. The market capitalization ranking of Aave, a "blue-chip stock" in DeFi lending, has quietly dropped to 61, while Compound has fallen outside the top 100, which is somewhat unexpected.)

Returning to collateralized lending, for NFTs, collateralization clearly incurs certain liquidity costs: when facing a rising token, one cannot sell and profit; when facing a falling token, one can only hold passively.

For institutions or core players holding leading NFT projects (such as CryptoPunks and BAYC), there may not be an intention to sell in the first place. Therefore, when there is a need to liquidate assets, collateralized lending is a choice worth considering. Moreover, the prices of leading NFTs are relatively stable.

Furthermore, for speculative purposes, retail investors may frequently buy and sell NFTs, and the overall value of NFTs is not high, making them relatively unsuitable for collateralization.

Thus, it is believed that NFT lending will be a niche market in the short term, primarily targeting holders of leading/blue-chip NFTs.

Three Types of Projects

Peer-to-Peer Model

In DeFi lending, Aave's predecessor Ethlend adopted a peer-to-peer model.

Arcade is similar in that its AssetWrapper contract supports packaging collateralized ERC721, ERC1155, and ERC20 assets, which then generates wNFT. Borrowers set the loan amount, repayment amount, currency, and time, then collateralize the wNFT and wait for lenders to match the order. Arcade plans to add an installment repayment model in future versions.

It is important to note that Arcade does not set automatic liquidation; in the event of a default, the borrower can still repay the loan before the lender claims the collateral.

For peer-to-peer platforms, whether lending demand can be responded to in a timely manner is directly related to the user experience of the platform. Arcade's platform data currently does not provide the average waiting time for matching. According to team members, lending requests at the floor prices of BAYC and CryptoPunks can generally achieve instant responses.

Additionally, the difference between NFTs and FTs lies in the fact that NFTs in the same series are unique, making it difficult for lenders to assess the rarity of high-value NFTs, or leading to discrepancies in collateral valuation between the borrowing and lending parties, increasing the uncertainty of lending.

Currently, Arcade's total loan amount on the platform has reached $9.5 million, supporting 49 NFT collections. At the end of last December, Arcade secured $15 million in Series A funding, led by Pantera Capital.

Liquidity Pool Model

The second type is the liquidity pool model, similar to Aave and Compound, such as Drops DAO.

In this model, loans do not have a maturity date, and interest rates are calculated based on asset utilization. The real-time prices of NFTs are quoted using oracles.

For a comparative analysis of the advantages and disadvantages of the peer-to-peer model and the liquidity pool model, Dyo Hu provides a more detailed explanation in this article.

For high-rarity NFTs, their value in the liquidity pool is effectively diluted, making the loan value for these NFTs less favorable.

Overall, the liquidity pool model is more complex and carries the risk of price manipulation and cascading liquidations. Given the generally low liquidity in the NFT market, there is a higher systemic risk. In the early stages of decentralized NFT lending, the peer-to-peer model is relatively more stable and reliable.

Centralized Model

At the end of last year, digital asset financial service provider Nexo partnered with Three Arrows to launch centralized NFT lending services. The exchange Kraken also plans to launch similar services.

Nexo offers a service akin to OTC, requiring a simple KYC application form. Currently, only BAYC and CryptoPunks are supported as collateral, with the collateralized NFT value needing to exceed $500,000, an annualized lending interest rate of about 15%, and a loan-to-value ratio between 10% and 20%, meaning an NFT valued at $500,000 can secure a loan of $50,000 to $100,000.

The centralized NFT lending model is suitable for institutions, but may seem less native for Crypto OGs.

Closing Thoughts

Comparing to the real-world art market, affected by the pandemic, the global art transaction volume in 2020 fell by 22% compared to the previous year, still exceeding $50 billion—just from the numbers, art collateral seems to have a decent market.

However, the authentication of artworks (including antiques) is often subjective, lacking authoritative guarantees, making valuation difficult; and due to a lack of liquidity, even after liquidation, whether the collateral can be monetized remains uncertain. To mitigate this risk exposure, traditional pawnshops often severely undervalue, typically offering very low loan-to-value ratios.

Returning to NFTs, compared to traditional artworks, the authenticity of NFTs can be verified by checking the contract address; valuation can reference the floor price of NFTs in the same series; and the online trading format makes monetization relatively easier. In terms of technology and operability, NFT lending faces relatively fewer issues.

Recently, Azuki quickly ranked 8th in OpenSea NFT trading volume, and similar blue-chip NFTs may emerge more in the future. Leading NFTs represented by CryptoPunks and BAYC, blue-chip NFTs represented by Doodles and Azuki, as well as parcels in Sandbox and Decentraland, will likely become the main targets for NFT lending in the future.