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This guide will address one of the most recent developments in blockchain technology, NFTFi, which intersects the world of non-fungible tokens (NFTs) and DeFi.
Many blockchain technology derivatives have intertwined to become a better version of conventional transactional activities. The likes of decentralized finance (DeFi) and MetaFi are typical examples of these upgraded traditional methods. Every day, chains of transactional activities occur across several blockchain sectors conventionally or deliberately. For instance, DeFi allows users to transact financial instruments without the presence of any centralized institutions like banks, brokerages, or exchanges.
This guide will address one of the most recent developments in blockchain technology, NFTFi, which intersects the world of non-fungible tokens (NFTs) and DeFi. Though it has a slightly synonymous mechanism to DeFi, it has more potential among blockchain enthusiasts. The innovation aims to rejuvenate the dead hopes of several NFT holders and enthusiasts. Since 2021, many NFTs have been lying idle and depleting in price. A significant percentage of top-tier NFTs’ price tags fell below the initial listing price.
In the summer of 2020, DeFi hit a total value locked (TVL) of approximately $10B from various protocols. In the summer of 2021, the NFT market boomed, gaining over $2.5 billion. A lot of people invested in buying NFTs or creating their NFT collections during this period. Considering the feats achieved by NFT and DeFi, the merger is full of potential and will likely cause a wave in the blockchain world.
NFTFi combines NFT and DeFi and aims to increase users’ access to more liquid assets. The intersection of both will open opportunities for NFT holders to make their NFTs a more liquid asset. Through NFTFi, NFT owners can put up their assets to earn yields instead of letting them idle in their crypto wallet. Owners can give up their NFT for a limited time for other users to enjoy the utility attached or get funds. This method replaces the conventional use of cryptocurrencies as collateral with NFT.
NFTFi operates wholly and functionally on blockchain technology. Therefore, interactions between NFT and DeFi will not elude using smart contracts. NFTFi tends to connect two caucuses of blockchain users, one with NFT and the other with no NFT. Either party can switch roles as a beneficiary of the mutual connection. The NFT owner initiates the process by listing the NFT on a marketplace, hoping the other party can apply to lend NFT or borrow funds. Once they reach an agreement, the smart contract locks the NFT in escrow for the stipulated duration. In most cases, the NFT owner sets the terms of the deal, which may include the length of the contract, loan amount, interest, and other parameters.
Several key components of NFTFi could be used depending on the blockchain settings. There are four possible uses of NFTFi in the blockchain sphere. NFT can intersect DeFi through NFT fractionalization, NFT derivatives, NFT renting, and lending/borrowing through NFTs.
NFT fractionalization is a process of sharing NFTs in smaller fragments that can trade as tokens on public and private marketplaces. During this process, the system locks up the NFTs in vaults. The vaults mint ERC-20 tokens representing a share of ownership of the whole asset. Users who cannot afford expensive NFTs like BAYC and CryptoPunks can gain access to them for a relatively cheaper amount. Platforms like Unic.ly, Fractional.art, and NFTX.io provide users with NFT fractionalization services.
Another use of NFTFi is NFT derivatives, which are very similar to regular derivatives. NFT derivatives allow users to predict and bet on the future prices of NFTs. Depending on their strategies and market forecast, they can perform long or short actions to hedge risk or generate cash from their assets. Less privileged users can gain access to trade high-end NFT with leverages. Additionally, NFT derivatives will spike the potential of the NFT market to become the future TradFi.
Renting is a popular feature of a utility NFT, as primarily demonstrated in the GameFi ecosystem. Most times, these transactional activities occur within the game’s ecosystem. NFT renting allows users to rent out their assets to other users for a fee. After listing the NFT on the rental marketplace, renting gives borrowers freedom from any financial commitment.
There are two forms of NFT renting: collateralized NFT renting and collateral-less NFT renting. In collateralized NFT renting, the prospective renter posts a collateral amount more than the borrowing NFT price. This method protects the lender from the dangers of losing the NFT. The smart contract then gives the NFT to the borrower for the agreed duration. As the name implies, borrowers do not need collateral in collateral-less NFT renting. In this NFT renting type, the lender generates a wrapped version of the original version with the same utility. Borrowers need to pay a rental fee to access the wrapped NFT. After the agreed duration, the smart contract burns the wrapped NFT and sends the rental fee to the lender.
Lending/borrowing through NFT is similar to the widespread DeFi lending. NFT lending allows holders to collateralize their assets to access a crypto loan. As expected, smart contracts control the on-chain lending process. This smart contract houses the assets, the liquidity (loan), and the terms and conditions of the loan.
There are three types of lending/borrowing in NFTFi: peer-to-peer NFT lending, CDPs, and lending pools. P2P NFT lending connects borrowers to lenders using NFT as collateral. If the borrower fails to repay at the agreed time, the collateralized NFT becomes awarded to the lender. Some projects also provide users with special pre-paid post purchases (BNPL). This borrowing mechanism allows players to initially pay a small amount to gain access to an NFT utility and pay up the rest within a short duration.
CDPs (collateral debt position) allow users to stake NFTs in a contract to generate stablecoin. CDP determines the loan size by calculating the floor price of an NFT collection. Finally, lending pools allow NFT owners to gather their assets, creating opportunities to earn whenever other users borrow them. Generally, this lending method encourages owners to provide liquidity.
Other sectors of the NFTFi ecosystem include NFT collecting, NFT hardware, NFT pricing, NFT portfolio management, aggregators, and NFT analytics.
NFTFi comes with many unique and spectacular benefits. Here are a few advantages of using NFTFi:
Meanwhile, there are also challenges that accompany using NFTFi. Challenges encountered using NFTFi include the following:
To wrap it up, the combination of DeFi and NFT will go a long way in reinstating the hopes of many NFT enthusiasts. The increased usage of NFT due to NFTFi might resuscitate the depleting economy. However, users must research the NFTs before hopping into any NFTFi transaction. As NFTFi usage progresses, users may suggest more sophisticated mechanics to curb available loopholes. Furthermore, NFT Finance can increase NFT’s popularity and widen the market by attracting new folks into the ecosystem.
NFTFi stands for non-fungible token finance. It is a new mechanism combining NFT and DeFi, allowing collateralization of NFTs for loans and other financial instruments.
NFTFi fully works on the smart contract consensus of the blockchain. In most cases, the NFT is locked in escrow until the agreement expires. Lenders can connect and agree with borrowers via the marketplace.
NFTFi also allows for flexibility regarding the agreement between lenders and borrowers. It enables the average investor to gain access to high-end NFTs.
NFTFi charges 5% of the rental charges/interest the lender collects. However, NFTFi does not charge lenders for performing a foreclosure.
Currently, NFTFi sectors include NFT renting, NFT fractionalization, NFT derivatives, and lending/borrowing through NFTs. There could be other sectors whenever NFTFi gains more exposure.
NFT fractionalization means dividing NFTs into fractions by creating ERC-20 tokens instead of an NFT. Each of these tokens represents a portion of the whole NFT and users can trade them on public and private marketplaces.