NFTs in Lending

Crypto education

The non-fungible token (NFT) market has absolutely blown up in the past year, seeing a 704% increase in trading volume from Q2 to Q3 of this year alone. With this explosion, the NFT space is seeing a new wave of ways that you can use your NFTs. When you purchase an NFT, the hope is that the price will increase as you hold the asset, and that you can sell it for more than you purchased it in the future. And while NFTs can be worth quite a lot, they are not liquid assets.

This is why a new way of utilizing your NFTs while you hold them has found its way to the crypto space. NFT lending is the newest innovative fusion between the lending and art crypto spheres.

What is NFT Lending?

NFT Lending is the cross-section between crypto lending and crypto art, where borrowers put an NFT up as collateral for a crypto loan. If you need a loan and have an NFT, you can use it as collateral, and lenders who have crypto to spare can find an acceptable NFT that they are willing to accept as collateral.

Real-world art loans, where works of creative visual art are used as collateral, can be found in the non-digital world. It was only a matter of time before the same idea was translated to the digital art and crypto world.

How Does NFT Lending Work?

Similar to many DeFi lending protocols, anyone can take out a loan as long as they have an NFT. Using an NFT lending platform, borrowers can request a loan for the NFT they would like to use as collateral. Lenders can then search for an NFT that they find acceptable, and offer what they believe is the fair value of the collateral. They usually determine this by examining the recent sales history of the NFT or the floor price - the lowest offer price at which an NFT from a particular series can be bought - of similar assets.

The lender proposes the terms of the loan, including the loan value, the repayment value, and the duration. Once both parties settle on and agree to the terms, the NFT is transferred into an escrow account and the rest of the loan is then carried out by a smart contract. If the borrower fails to repay the loan and interest by the end of the determined duration, then the NFT is transferred to the lender. If the borrower pays back the loan plus interest in time, their NFT is then released back to them.

With regards to what borrowers can expect, loans are typically approximately 50% of the value of the NFT, and interest rates can range from 20-80%. Interest rates will depend on the perceived desirability of the NFT.

Why Put Your NFT up as Collateral?

NFTs can be worth quite a lot of money, but since NFTs are not liquid assets, owners have no access to that money until they sell their NFT. With the crypto that a token can be worth, users can earn crypto in DeFi protocols, trade crypto for profit, or even just have crypto to use for whatever purpose they’d like.

Because of this, NFT holders are becoming more interested in gaining liquidity by using their token as collateral. Many lenders are also interested in lending their crypto, not only because they can make money if the loan is repaid, but because they are interested in the NFT themselves. If a borrower defaults on a loan, the lender gets the NFT essentially at a 50% discount.

What are the Current Issues and Risks with NFT Lending?

The current issue with NFT lending is that it’s hard to value an NFT. Currently, borrowers are at the mercy of lenders when it comes to value because there isn’t a sufficient price discovery mechanism. Valuing an NFT is hard for several reasons:

  1. Volatile crypto market prices

Since crypto can be volatile, sometimes the price of the asset can fluctuate greatly with prices, making it hard to value consistently.

  1. Some NFTs are not unique - multiple NFTs may be sold for one work

In this case, lenders have to consider how many other copies of the NFT were sold and if that affects the demand for the NFT and therefore the price.

  1. Many NFTs do not include any ownership interest in the underlying work and do not transfer copyright

NFTs are not the digital artwork itself, they are a crypto asset that point to the artwork. Lenders have to consider what ownership rights they get to the NFT, if any at all. Many NFTs do not transfer copyright either, but may include rights to display the NFT on the web non-commercially.

  1. An NFT may impose licensing conditions on the NFT purchasers, such as a royalty payable to the artist on any future resales of the NFT at a profit

Licensing conditions are also an important factor to consider because any commissions payable to the artist upon profitable sale change the value of the NFT for the lender should they eventually sell it.

Risks

As with any financial tool, there are risks associated for both sides.

Borrowers risk losing an important financial asset, like one borrower who took out a 3.5 ETH loan for their NFT, the price of which shot up to $340,000. The digital asset was transferred to the lender after the borrower failed to repay the loan. While it was that lender’s lucky day, if the NFT put up as collateral drops significantly in price or becomes hard to resell, lenders can be out more money than they originally intended.

How Can I Obtain an NFT Loan or Loan my Crypto?

You can obtain an NFT loan or loan your crypto for an NFT by using an NFT lending platform. There are currently a few like NFTfi, Stater, and TribeOne, and more are likely to pop up as the NFT space grows. You’ll need to make an account, after which you can either put your NFT up for a loan and wait for an interested lender to make an offer. Or if you would like to lend out your crypto, you can browse the NFTs up for collateral and make an offer on any that interest you. Once each party agrees to the terms, a smart contract will handle all the rest of the transaction.

The Future of NFT Lending

Currently, NFT lending is only in the beginning stages. There are only a few platforms for lending, but as the NFT space grows, so will the options for lending. Newer blockchain networks like Polkadot and the upcoming Facebook-backed Diem project will present new networks to mint NFTs on, and it’s likely that lending spaces will follow. As more infrastructure is built and the market has time to expand and settle, valuing NFTs will become easier because the market will be more liquid and stable.

The construction of platforms for minting and lending NFTs on different networks will help the market grow and stabilize, and Pontem is helping speed this up by creating a platform to quickly build, deploy, and test dApps - such as NFT minting and lending platforms - on Polkadot, as well as other popular blockchains such as Ethereum.

Conclusion

This new fusion of different crypto spaces is helping expand the crypto market and the ways that crypto users can use the digital assets they hold. While of course NFT-backed loans carry risks, they interest many NFT holders who are looking for liquidity as well as crypto holders looking to gain NFTs at a discount or make money off the crypto they’re holding. It should be exciting to watch this new space expand in the future and Pontem is aiding in this expansion by providing tools to create the necessary platforms for it to happen.