What is an NFT loan and how does it work?
NFT loan explained
NFT loans allow NFT holders to take loans against their assets. It has grown in popularity as a way for investors to unlock liquidity and access credit.
Non-fungible tokens (NFTs) can be bought and sold, owned or traded, and are now part of other decentralized finance (DeFi) arrangements, including NFT loans. Demand for NFT loans has increased in part because the intangible or unique nature of NFTs makes them difficult to use in other DeFi sectors. For example, it is not possible to share or issue farm NFTs in the same way as cryptocurrencies that scare investors.
Compared to cryptocurrencies like Bitcoin (BTC), there is less liquidity in the NFT market. This is because NFTs can be completely unique and it can take an owner a long time to find an interested buyer for an NFT.
NFT loans allow NFT holders to unlock liquidity, take out loans and diversify their portfolios. However, NFT loans also carry risks due to price volatility, regulatory uncertainty and other factors.
There are several types of NFT loans:
Peer-to-peer NFT lending
In peer-to-peer NFT lending, NFT holders use the platform to list NFTs as collateral to receive loan offers from other users.
Peer-to-Protocol NFT Lending
This NFT deals with lending directly from the DeFi protocol or platform. Borrowers secure NFTs by locking them into protocol smart contracts.
Insolvent debt position
In this method, a unique asset on the blockchain is created by representing the platform or provider as a transparent record of the NDP (NDP). MakerDAO's Collateral Debt Platform (CDP) can also trade the NFDP, which allows users to pledge Ether (ETH) to the stablecoin Dai (DAI).
NFT rentals
NFT assets are transferred from one user's wallet to another through the NFT rental platform for a period of “rental” to obtain the benefits or benefits provided by the NFT.
How NFT lending works
DeFi platforms enable peer-to-peer NFT lending or peer-to-peer protocol lending. NFT holders lock up their assets as collateral in smart contracts.
To obtain peer-to-peer NFT loans, owners use an NFT marketplace or NFT lending platform where they list NFTs as collateral and receive loan offers from lenders. The platform may provide valuation tools or market data to help determine the fair value of an NFT. The NFT owner can choose the offer they like, accept it and receive the loan, usually in a stablecoin, through a wallet.
The platform puts the NFT into an escrow smart contract for the duration of the loan. If the borrower repays the loan and interest before the end of the loan period, the NFT will be returned. The marketplace charges fees primarily based on the principal amount of the loan. If the borrower defaults on the loan, the lender receives NFT, which is usually more than the value of the loan. Also, the lender can liquidate the NFT to recover their losses or keep the NFT.
Peer-to-protocol lending works a little differently. The owner of the NFT borrows directly from the lending protocol, placing the NFT as collateral, which is locked in the protocol's smart contracts. NFT lending platforms use exchange providers that add to the lending protocol pool to make crypto funds available to borrowers.
How NFT fractions and loans help investors unlock liquidity
Fractionation of NFTs makes high-value NFTs accessible to more investors and allows holders to unlock liquidity of tokenized fractional NFTs.
The intangible nature of NFTs often makes them indivisible. They generally have to buy or sell. This is in contrast to fungible cryptocurrencies like BTC, which are divisible; Investors can own fractions of Bitcoin called satoshis.
The NFT loan space now features NFT fractionalization. Decentralized NFTs are represented by small, fuzzy tokens, each token representing a share of ownership in the original NFT. Invulnerable token holders, especially those with high-value NFTs, can generate tokenized fractional NFTs, another way to unlock liquidity in their NFTs. It gives investors access to these assets and their values and makes high-value NFT investments more accessible to investors who cannot afford to buy the entire NFT.
NFT lending and fractionation both aim to increase the liquidity of NFTs. Additionally, NFT fracking expands the investment pool for NFT lending and may even lead to strategies for owners to combine fracking and lending to unlock capital from NFTs.
An NFT holder can sell the distributed shares to collect quick cash. You can then get a loan in the NFT loan market using the remaining unallocated portion of the NFT as collateral. Owners can access a much larger amount of capital through this method than they could through dividends or loans alone.
Advantages of NFT loans
Unlocking NFT liquidity for owners and creators of digital art, NFT lending facilitates borrowing without the need for credit checks.
NFTs can represent anything from digital art and collectibles to real estate and other fiat assets. The price of NFTs varies, but some collections have NFTs that sell for extremely high prices. However, there are many other NFTs with very modest values.
Liquidity and access to capital
NFT loans allow holders to access or unlock NFTs from their portfolios without having to sell them. Investors can use this route if they want to buy other assets or quickly unlock capital for various purposes.
DeFi and digital art
Digital Art NFTs have proven popular in the crypto space. NFT lending offers a cross between DeFi and digital art. Serious collectors and artists have the opportunity to use the space.
Zero credit checks
NFT loans, like other DeFi loans, do not require the credit checks required in conventional finance. Borrowers with poor or low credit scores can get loans through the crypto space. However, some NFT lending platforms may conduct basic Know Your Customer (KYC) checks to comply with regulations and reduce fraud risks.
Risks of NFT loans
The volatility of NFTs increases risk, smart contracts can be vulnerable to attacks, and regulatory uncertainty affects the market.
Along with the general risks associated with cryptocurrencies, there are specific risks to NFT lending.
Flexibility
The value of NFTs is volatile, similar to cryptocurrencies. This complicates assessing the value of NFTs to underwrite loans. If the value of the NFT falls below the value of the loan, it may lead to liquidation, where the borrower defaults on the loan and the NFT is transferred to the lender.
Liquidity
NFT lending can be attractive because it allows NFT holders to unlock liquidity when NFTs are difficult to sell. However, the similar lack of liquidity of NFTs means that if the borrower defaults on the loan, the lender and the new owner may face the same problem of selling the NFT to get or recover their funds.
Smart contracts
Proprietary NFTs and credit terms are locked into modern contracts, but there is always the risk of bugs or attacks that could result in the loss of NFTs or funds.
Regulation
The same regulatory uncertainty that applies to the crypto and DeFi space extends to NFT lending. Changes in regulation may affect the market and the viability of NFT lending, or may require stakeholders to change or comply with compliance requirements.
NFT lending can address the low liquidity problem of NFTs and allow owners to utilize their assets instead of accumulating value. There are additional drawbacks though: NFT mining can be labor-intensive, and Ethereum gas fees for approving transactions can be high.
