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Will Booming NFT Market Spur New DeFi Lending Wave?

The whole world is struggling to wrap its head around non-fungible tokens (NFTs), including DeFi. But DeFi is trying.

“Over the last two weeks NFT sales have exploded to levels well beyond the NFT boom seen in March,” says a new report by CoinMetrics. Obviously, that’s driven in part by genuine interest but also by snagging something on the cheap that soars in value. And there’s been a lot of that going around. 

When people in the analog world want to make use of something valuable without selling, they turn to a lender who will accept it as collateral for a loan. That’s definitely happening in decentralized finance (DeFi), but not as quickly as one might expect considering all the other financial innovation that’s occurred on the blockchain.

Hard Spikes

“It’s a gradual understanding of this opportunity,” Vanessa Grellet, who leads portfolio growth at the venture firm CoinFund, told The Defiant in a phone call. “It needs to be much more user friendly.”

CoinFund has made many investments into financing NFTs. These include backing NFTX, which creates NFT indexes; Upshot, which helps with pricing; and NFTfi a marketplace for borrowers and lenders who will accept NFTs as collateral.

The NFT market is growing fast. CoinMetrics wrote that OpenSea, the leading marketplace for NFTs, has already seen a billion dollars in sales volume in August. The increased interest is also easy to see looking at charts for several NFT related ERC-20 tokens. Axie Infinity’s AXS, Dapper Labs‘ FLOW and Meme’s MEME token all show hard spikes in price in late July or early August.

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Vanessa Grellet, Head of Portfolio Growth at CoinFund

But that hasn’t translated into leaps in business for companies working to close the gap between the two sectors.

NFTs and DeFi may be closely related, but they don’t necessarily move in lockstep. In some ways, NFT powered DeFi had already begun perking up before sales did, but the uptick is more sedate than what’s been seen in the sales market. Mostly that’s because there is still more friction on the financial side than there is in trading.

The most straightforward blend of NFTs and DeFi is making loans against valuable NFTs.

Best Month to Date

NFTfi is probably the best known place for lending against digital art and collectibles. It has a peer-to-peer marketplace where NFT holders can post items and ask for loans, and lenders can decide whether or not to accept the terms.

Stephen Young, the CEO of NFTfi, told The Defiant via email that his company hit their 1,000th loan in July, which was also their best complete month to date in terms of loan volume. That said, August has already — a little over halfway in — basically matched July, for loan volume.

So far the company has facilitated $5M worth of loans on NFT collateral, with a lot of that volume coming recently. Still, $5M seems small compared to CoinMetrics’ figures on the sales side. 

But as more NFTs prove they can hold their value, there will be more lending to do.

Source: NFTfi

Lag the Sales Market

The two NFT projects that have driven the most lending have been Autoglyphs and Art Blocks. Young explained that these both have relatively high prices and a lot of sales volume, making it likely a lender can recover lost funds quickly in a default.

“Some lenders also use NFTfi as a way to potentially acquire assets. They offer loans on high value Art Blocks and glyphs that don’t go for sale very often in the hopes that the borrower defaults,” Young explained.

There’s a lot of reasons people take out loans as well, including funding yield farming, hedging the risk that the price will fall, or just buying more NFTs.

The market for such loans is growing but not exploding. “In general, we lag the sales market,” Young wrote. While it’s a new buying boom now, “a lot of those sales are first time sales. NFTfi is only useful if you already own a fairly high value, high quality asset with a proven secondary market.”

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Source: NFTfi

Early Lending Project

NFTfi is not alone in this business. It arguably started with Alex Masmej, the founder of the social network for NFTs, Showtime, who ran an early NFT lending project that wrapped up late last year.

A small set of companies have started offering NFT-based loan products or will soon. Stater is up and running, but could not be reached by the Defiant. Pawn.fi is in closed early access. 

Others are also in the works, such as Taker Protocol. The NFT marketplace and minting service, Rarible, is in the process of partnerships that will allow it to be part of facilitating loans, according to co-founder Alex Salnikov. The money market Aave has something in the works as well. And C.R.E.A.M. Finance did a one-off loan to PleasrDAO, an NFT collective, using its collection as collateral.

I’m hoping we’re on the cusp of a DeFi/NFT boom, but we’re definitely not quite there yet.

Alex Gausman

It’s still early for anyone looking closely at this business. Grellet highlighted a variety of pieces that need to get more built out in order for DeFi and NFTs to complement each other fully.

More sophisticated data analytics is needed for one. Right now, she explained, the various marketplaces (such as OpenSea, Rarible and SuperRare) function in a fragmented way from a user perspective. For example, there’s no easy way to compare prices across markets or to see comparable sales across markets over time.  

Borrower Default

Borrowers also need a way to bundle NFTs into one separate token in order to function as a single unit of collateral.

And liquidity remains low compared to the token market, even with the new sales boom. Liquid markets reassure lenders that they can sell an NFT to recoup their losses if a loan defaults, for example.

But the most important issue in financializing NFTs is price discovery, according to Grellet and others The Defiant spoke to. How can a lender decide how much to offer as a loan against an NFT if they don’t reliably know what the NFT will sell for should the borrower default?

One answer in pricing digital collateral is to offer loans against fractions of a bundle of NFTs, such as the ERC-20 tokens NFTX makes to represent pieces of just such bundles. Alex Gausman, its founder, said his company is working on getting the index tokens their platform issues established as collateral for lending.

Pool of Assets

Each NFTX index has its own token, which reflects the base or floor price for that group (for example, one PUNK token is worth any one CryptoPunk in their index for that asset). Each NFTX index then gets placed in the automated market maker, Uniswap, so there’s always a reference price for lenders

“I’m hoping we’re on the cusp of a DeFi/NFT boom, but we’re definitely not quite there yet imo,” Gausman told The Defiant over Discord. “I think it’s still early for most DeFi integrations using NFTs but getting really close.”

Grellet agreed: “As long as this pool of assets is growing and visibility into the market is growing I think we’ll get to a very exciting place.”