In the first column for CMC, Collection.xyz gives an overview of the upcoming vertical – NFT Finance (‘NFTFi’) and how it is poised to be the next frontier in the NFT industry.
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What is NFTFi and how does it compare to DeFi?
In DeFi, users pledge their fungible tokens as loan collateral to finance transactions and enhance the value of owning these tokens. For example, users can borrow against their ETH to receive USDC. After which, they use USDC to deposit into a DeFi DEX (decentralized exchange) such as Curve to contribute liquidity to a USDC / USDT / BUSD 3-pool. The LP tokens received from taking these liquidity positions can then be deposited into Yearn Finance, a DeFi lending protocol for automatic rebalancing, generating yield and receiving $CRV tokens (Curve DAO tokens).
Relative to DeFi, the core pillars of NFTFi are still early in development. Protocols such as lending & borrowing, decentralized exchanges, yield farming and derivatives are common pillars between DeFi and NFTFi. In addition, the uniqueness of NFTs as an asset class opens up new product verticals, such as fractionalization, rental, pricing and marketplaces. This adds greater vibrancy to the growing NFTFi ecosystem.
NFTs as an asset class could be larger than fungible tokens
In traditional finance, non-fungible assets such as real estate form a more significant asset class than fungible assets such as stocks. The value of the world’s real estate assets rose 5% in 2020 to $326.5 trillion, making it the world’s most significant store of wealth and more valuable than all global equities and debt securities combined. Consumers tend to utilize the financing market to finance the purchase of real estate with $2.7 trillion in US mortgages refinanced in 2021 while margin debt reached $650 billion in the same year. Should Web3 gaming, metaverse and other ecosystems take off, the expected market capitalization of NFTs will likely exceed that of the total crypto market capitalization of $1T.
Current state of the NFTFi market
The health of DeFi and NFTFi markets is determined by total valued locked (TVL), which measures the total value of all assets locked into each respective set of protocols. Currently, the NFTFi market stands at approximately $175M TVL, which pales in comparison to the DeFi market at approximately $54B TVL.
DeFi enables the permissionless transfer of value with fungible tokens, while NFTFi does so with non-fungible tokens, though at a more nascent stage. However, given the fast-growing development trajectory and innovation speed at which NFTFi projects are moving at, NFTFi is well-positioned to grow by 100X to capture a meaningful share of the $54B DeFi TVL.
Despite the macro-economic challenges faced by the NFT and crypto market in general, we are still seeing significant trading activity in the NFT market with 70.66 billion dollars in total NFT secondary sales volume. The number of monthly unique NFT traders in October 2022 stands at 1.11 million and the number of weekly NFT traders stands at over 135,000 for the last week of October 2022. That is a significant number of users!
At the collection level, Art Gobblers enthusiasts traded over $10M in value over a day. It surpassed the 30D volume traded on BAYC collection in just a day.
Top NFT collections by volume traded Source: NFTGo, Nov 3, 2022.
With NFTFi, the development in the financial layer of NFTs will help accelerate the growth of the NFT market and bring in many more new users into the NFTFi and broader NFT ecosystem.
The NFTFi ecosystem
The NFTFi ecosystem can be divided into nine verticals including: lending & borrowing, pricing, buy now pay later (BNPL), fractionalization, rental, derivatives, liquidity provision, marketplaces and infrastructure. These key primitives have to be developed for the financial layer of NFTs to function efficiently, and generate liquidity and yields from NFTs. Here are some of areas of the NFTFi ecosystem which are developing:
NFTFi for borrowing and lending
NFTFi borrowing and lending protocols help unlock liquidity and yield for NFTs, assets famous for their illiquidity and being "just a jpeg". No longer do holders have to fire-sale their NFTs in the event that they need liquidity. The cumulative borrow volume from the top six NFT lending and borrowing platforms, such as NFTfi, BendDAO, Arcade, JPEGD, Drops, and Pine stands at $489.06 million USD.
NFTfi and BendDAO have the largest number of cumulative users, having 16,353 and 5,433 users respectively. However, they differ in lending methods. NFTfi is a peer-to-peer lending protocol. In NFTFi, borrowers can list their NFT as collateral and receive loans from lenders in WETH or DAI. BendDAO is a peer-to-pool liquidity protocol. Borrowers can use their NFTs as collateral and immediately borrow ETH through the loan pool. However, a limited number of collections like Bored Ape Yacht Club (BAYC), Mutant Ape Yacht Club (MAYC), Azuki and CryptoPunks are supported at the moment by BendDAO for a select group that are interested in these blue-chip collections.
NFTFi for automated market making and DEX
Automated market makers (AMM) add an additional primitive to simple two-sided NFT marketplaces. Sellers of an NFT no longer have to wait for hours, or even days, in hope that someone would buy their listed NFT.
Users can deposit NFTs and ETH to create a liquidity pool that anyone can buy and sell against anytime. Now you can be the market! Liquidity and NFTs providers can earn yield through the trading fees collected, as people trade against your pool.
NFTFi for yield and composability
We can tokenize both the liquidity committed to the AMMs, as well as, borrowing and lending protocols with ownership tokens (LP token). LP tokens can be used as collateral, allowing even more flexibility and usage out of your assets. Yield incentives can also be rewarded to target LP token holders. This enables the seamless distribution of incentives to liquidity providers, unlocking a healthier and more liquid NFT market.
Liquidity providers who deposit two-sided liquidity in NFT and ETH, and stake their LP tokens into incentivized vaults on Collection.xyz currently receive rewards in the form of ERC-20 tokens. For example, the Azuki <> ETH vault on Collection.xyz incentivizes two-sided liquidity with 0.46 WETH and 10 USDC worth of rewards. This encourages liquidity providers to provide more two-sided liquidity for the Azuki NFT collection to earn rewards.
Challenges in the NFTFi market
The NFTFi market is still in its nascency, and it will continue to face limitations and challenges. However as the space develops, we will see NFTFi tools and mechanisms improving over time to better accommodate market conditions and user needs.
Liquidity issues in the general market
Given the general market outlook, liquidity issues should remain a challenge for the entire NFTfi market, regardless whether it is an AMM, lending or BNPL product. As an industry, we should work together to attract new liquidity or unlock existing liquidity into NFTs and NFTFi.
AMMs like Sudoswap see weaker activity as compared to general marketplaces
The NFTs that users tend to deposit to create liquidity pools on NFT AMMs generally have a lower floor price below 3 ETH (lowest last traded price of the NFT collection). The TVL of ETH locked in the top 15 liquidity pools by TVL stands at roughly $2M in value.
Top collections by total value locked (TVL) on Sudoswap. Source: Sudoswap, Nov 3, 2022.
Single-sided liquidity pools dominate
Taking a deeper look at the liquidity pool provision data, the majority (86%) of liquidity pools created on Sudoswap are one-sided pools with either NFTs only looking to be sold to ETH or the inverse. Unlike Uniswap and other DeFi protocols where all of the pools are two-sided liquidity pools, we see a different pattern on the Sudoswap side of things.
NFT pools created from inception to date. (Source: Dune Analytics dashboard by 0xrob, Nov 3, 2022.)
Token design could dis-incentivize activity
It is still early for governance token distribution in the NFTFi space. Tokenomics is still a challenge and the right mix of incentives needs to be achieved to ensure adequate incentivization. Since the tokenomics announcement of Sudoswap tokens, the daily liquidity pools have fallen and dipped drastically. Comparatively, the daily trades executed have been fairly consistent albeit declining in a gradual manner.
Daily Sudoswap pools created. (Source: Dune Analytics dashboard by 0xrob, Nov 3, 2022.)
Daily unique trades on Sudoswap. (Source: Dune Analytics dashboard by 0xrob, Nov 3, 2022.)
NFTFi innovation and investment continue to pace forward
Despite the challenges, we observe a significant number of talented teams and investment professionals building and funding the NFTFi market. The estimated funding accumulated by NFTFi startups has exceeded $128M to date.
Fund raises by NFTFi protocols and companies cumulative (Source: Multiple)
Teams such as Metastreet, Collection.xyz, Spice Finance, and Blur have also recently announced new funding rounds from some of the most established funds in the crypto space such as OpenSea Ventures, Coinbase Ventures, Dragonfly Capital, Defiance Capital, Ethereal Ventures, Nascent, Paradigm, Shima Capital and more.
With Metastreet’s latest funding round, they’ve launched a product, Powersweep, to enable NFT traders to buy and sell NFTs on margin via NFT orderbooks. By increasing the purchasing power of NFT buyers, they will contribute significant velocity to the books of various marketplaces and protocols. They have already facilitated $40M of lending volume to date.
Notably, Collection.xyz launched an NFT liquidity yield incentive product to make the Sudoswap AMM LP positions composable by issuing an LP token upon deposit. Anyone can create a vault using the protocol to distribute liquidity incentive rewards to liquidity providers. In the next version, they will make it easy to incentivize with NFTs along with ERC-20 tokens. They have also revealed additional investment to develop better AMM features, such as enabling a broader coverage of NFTs in every collection to enhance liquidity pool provision and trading. These new features are slated to launch in the next few months.
Meanwhile, Spice Finance is aiming to be the Yearn Finance of NFTFi by aggregating lending liquidity and optimizing capital deployment. Their goal is to unlock first-class yields with NFT lending opportunities for anyone. They are currently in beta and will launch in the coming months.
The Spicyest and Protecc teams have emerged as two of the front-runners dedicated to pricing NFTs and making markets using proprietary strategies. Both teams have considerable relevant experience in quantitative trading and NFT DAO ecosystems. As we observed from the size of players in the DeFi space, sophisticated teams will be able to deploy significant capital to provide liquidity, farm yields and structure products for institutions looking to access the markets.
Paradigm-backed Blur launched its NFT marketplace with trading features targeting professional traders, such as floor sweeping, trait sniping and portfolio analytics. Blur allows users to see the floor price for specific attributes which helps users to accurately value their own assets. Blur’s October 2022 launch has been popular with pro-NFT traders and high-volume traders. Much of the hype has also been surrounding the Blur token which is distributed in a creative fashion to users of the platform.
Blur accounts for 25% of all NFT Volume (Source: Dune Analytics)
Since there are no trading fees, many users have also been observed to favor trading with Blur as compared to OpenSea. In fact, Blur has taken up a significant chunk of NFT trading activity, where approximately 25% of all NFT orders are being filled on Blur.
The future of NFTFi
We are undoubtedly in the depths of a bear market. A crypto winter, if you will. Price, on-chain activity and overall sentiment have dropped tremendously from all time highs. The demise of institutions once thought to be at the cutting edge of crypto, like FTX and Three Arrows Capital, have made headlines in spectacular fashion.
Despite this, teams across NFTFi soldier on to build an ecosystem with composable, permissionless and innovative protocols, designed to push NFTs to achieve their full potential. Just as DeFi summer was led by teams that built through the previous bear market such as the likes of Uniswap, AAVE and Compound – the future boom in NFTFi will be led by the protocols building today.
4. Multiple sources:
17. Multiple sources: