NFT Financialization: Six Verticals Creating The Future of NFT Finance
While the NFT market has grown a lot in the past years, it still faces a great challenge: the illiquidity of NFTs. In this scenario, NFT financialization came to bring more financial opportunities around non-fungible tokens by making them more liquid. In this article, you will learn the six verticals of NFT financialization and how they can impact the future of blockchain technology.
What is NFT Financialization?
NFT Financialization is a phenomenon where a new financial layer surrounds NFTs, thus ushering in new utility and financial marketplaces. If non-fungible tokens were initially the tokenization of digital art, music, etc., now NFT finance is becoming its own industry through loans, fractionalization, speculation, and more. Decentralized Finances (DeFi) techniques and strategies are now being explored to help boost these digital art assets that were once illiquid.
Why Is NFT Financialization Important?
NFT financialization represents an opportunity to expand the adoption of NFTs by increasing liquidity in the industry. Here is why.
The NFT space has been experiencing rapid growth and going beyond NFT marketplaces. According to The Block Data, it reached an all-time high volume of $6.13 billion in January of 2022, followed by a drop due to the harsh crypto crises. Still, the volume of transactions is still extremely higher than just two years ago. Yet, the liquidity of NFTs did not follow the same pace of growth. A collection of NFTs is made of many independent tokens, each one with its own price. Thus, it can become tricky to calculate the value and liquidity of all that.
Fortunately, there are some strategies that create financial verticals around NFTs, allowing them to become more liquid. So far, six main verticals have been developed to increase the liquidity of NFTs.
The Six Verticals of NFT Financialization
As mentioned, there are six main verticals composing NFT financialization. These financial layers built around NFTs allow investors to access more liquidity and yields in this industry. So, let’s take a closer look at each of them:
Being non-fungible is one of the aspects that made NFTs so successful. However, it is also a key reason why they have such low liquidity. With that in mind, NFT fractionalization refers to making non-fungible tokens more fungible. This is done by dividing an NFT into small fungible tokens, therefore, dividing its ownership. This practice is done in the traditional art market, where many investors own a fraction of an art piece. This allows them to include expensive assets in their portfolios without the full costs.
In that sense, NFT fractionalization is especially ideal for blue-chip NFTs that can cost hundreds of thousands of dollars. By fractionalizing them, more investors can co-own these expensive assets without needing to invest exorbitant amounts of money. In addition, the risks and costs associated with buying these digital art pieces are also fractioned. Just keep in mind that the prices of these fungible tokens don’t necessarily track their original NFT. Instead, investors can trade them at a discount or a premium to the original valuation.
There are some platforms that allow you to take part in NFT fractionalization, such as Unicly, Fractional. However, the highlight of this vertical is probably NFTX. This decentralized protocol pools NFTs of equivalent value into index funds. It works more or less like this: users deposit their NFTs into a vault and mint a fungible ERC20 token, called Vtoken. This token gives users a claim on a random asset and/or a specific NFT on the vault. NFTX’s model offers pros and cons. Yet, overall, it enables users to access liquidity from their non-fungible tokens while decreasing value fluctuation risks.
This practice has done a lot to improve the liquidity of the NFT industry. NFT Lending consists of collateralizing your NFT in exchange for a crypto loan. Let’s say you need a crypto loan, but to get it you need to put an asset as collateral. NFT lending allows you to put your NFT as collateral. Then, the lender supplies the requested loan with interest. In case you can’t repay the loan and interests according to your agreement, the lender will then receive collateral, aka your NFT.
Usually, NFT Lending is an automated process performed on the blockchain by smart contracts. There are some ways of carrying out NFT lending. Among them, the following two models stand out as the most used ones:
The name is very self-explanatory, and it works very similarly to bank loans. Taking place in peer-to-peer NFT lending platforms, it usually consists of a borrower listing their NFTs and receiving loan offers from lenders based on their perceived collateral value. If the proposition is accepted, the loan will be transferred to the borrower’s wallet. Concurrently, the NFT will be automatically stored in a vault where it will stay until the loan is either repaid or expires.
An example of this type of lending is NFTfi. This platform has emerged as an early leader in this sector by providing smooth peer-to-peer NFT lending. It allows borrowers to receive wETH and DAI loans by collateralizing their NFTs. On the lenders’ side, it enables them to make a profit, acquire NFTs for a discount, and support projects they are passionate about.
This model enables NFT holders to borrow straight from liquidity pools instead of waiting for an appropriate lender pairing. Different from the previous lending model, in peer-to-pool NFT lending, liquidation happens when the loan health (a numeric representation of safety) falls below a given level. After this point, the borrowers usually have around 48 hours to repay the loan and recover the collateral. Also, the value of an NFT is based on its floor price. Thus, this model is not ideal for rare tokens.
The first decentralized peer-to-pool NFT liquidity protocol, and one of the most popular ones, is BendDAO. By using the peer-to-pool approach, this platform allows users to access instant NFT-backed loans.
For many, the key reason to purchase NFTs is the utility and the access gained. This is another aspect where financialization is changing user exposure to these digital assets and making them more powerful with rental terms. In this scenario, some investors might have specific and temporary goals with a given NFT, making the full purchase not worth it. Or, the NFT they have in mind is not available for sale. Enter NFT rental. As the name implies, NFT rental is when NFT holders lease out their digital assets like a Bored Ape Yacht Club NFT for temporary use in exchange for upfront capital.
While this is a very new approach to the financialization of NFTs, NFT rentals present great potential to the industry. For borrowers, it can improve the accessibility to the NFT utility side of the project. For lenders, it can allow them to earn passive income from an illiquid asset. For the NFT space overall, it makes the market more dynamic and expands the opportunities for the financialization of one single NFT.
An exciting example of an NFT Rental platform is reNFT. The platform allows users to rent NFTs for an array of usages, such as renting virtual land for metaverse events, subscribing to a new meta wardrobe every week, or renting gaming assets. It also allows lenders to build their own marketplace and have access to other financialization tools within reNFT. Other interesting NFT rental platforms are IQ protocol and Vera.
There is a financialization opportunity when pricing NFTs. While creators and NFT holders can choose how much they want to sell their NFTs for, four pricing strategies optimize their gains.
Machine Learning-Based Pricing
There are a number of platforms that offer NFT holders a statistical analysis by machine learning to identify the value range of a given NFT. The machine learning aspect enables an analysis of the historical sales and metadata of the NFT to come up with the most accurate pricing at scale.
When it comes to machine learning-based pricing, Upshot is usually the preferred platform. It offers near-real-time price feeds for NFTs, enabling a whole new set of financial primitives. On top of pricing information, Upshot provides other data, such as metadata and collection-level information.
Time-Weighted Average Price (TWAP)
TWAP is a trading indicator that calculates the average of NFT prices as they rise and fall in a specific period of time. By taking the average of various trades over a predefined time period, manipulating market prices becomes more difficult and costly. However, TWAP can only be used for NFT collections with an active and large market, which can be a downturn for some.
Peer Prediction Pricing
In this strategy, creators or NFT owners can let their tokens be evaluated by other users on what the price should be. In other words, it’s an NFT appraisal. Participants receive rewards for their opinions, calculated by a “mutual information” index (a generalization of relevance). This method, however, is not very efficient or accurate unless the NFT in question is extremely rare and relevant.
Abacus is a popular platform that uses peer prediction pricing to provide NFT holders with liquid backing and accurate appraisers with rewards. It does so by creating Appraisal pools where peers evaluate the NFTs. Thus, it decreases the volatility of the token, benefiting all parts.
The many financial verticals surrounding NFTs, such as the ones mentioned in this article, ultimately affect the pricing of your asset. That is what derivates pricing strategy consists of pricing your NFT also based on the financialization verticals based on it by using financial derivatives and auction mechanisms. This gives real-time pricing of the NFT and its own surrounding market.
With volatile pricing and so many financial verticals surrounding NFTs, the amount of data to analyze before making an investment decision can become overwhelming. NFT aggregators serve as a way to simplify that. They showcase listings from multiple marketplaces and platforms under one single and simplified interface. This way, NFT enthusiasts can compare prices and trade NFTs from one place. NFT aggregators are a much-needed tool as the market grows increasingly fragmented.
Gem.xyz is an example of a very complete and easy-to-navigate NFT aggregator. Acquired by the giant Open Sea back in April 2022, Gem.XYZ offers a large set of NFT data to ease the trading process, which can also be done on the platform. It is also a price leader in the NFT industry, offering up to 40% savings gas fees in comparison to NFT marketplaces. By constantly adding new features to its platform, Gem.xyz maintains its position as one of the best NFT aggregators available.
Probably the most sophisticated layer of NFT financialization, NFT Derivatives consist of products that enable users to speculate on future prices of non-fungible tokens. Basically, users and traders can take long or short positions on NFTs and make profits from them. This allows NFT holders and traders to increase these assets’ liquidity, hedge risks, and maximize profits.
The core idea of NFT derivatives is deriving any contract or token from a given NFT. This derived token will be a fungible representation of the underlying NFT, allowing the users to speculate and even stake it. Some use cases of NFT derivatives are speculating on floor prices or building NFT swapping protocols. NFTperp, for instance, applies the idea of NFT derivatives by offering a platform where users can speculate on NFTs floor prices.
NFTperp, for instance, applies the idea of NFT derivatives by offering a platform where users can speculate on NFTs’ floor prices. Among the features NFTperp offers, it is the opportunity to short NFTs, which until recently were un-shortable assets. The platform also allows users to long NFTs, trade blue-chip NFTs using any amount of collateral with perpetual futures contracts, and trade with up to 5x leverage. All these features make NFTperp a very complete and innovative protocol in the NFT industry.
Another platform in the NFT derivatives vertical is Putty Finance, which consists of a peer-to-peer exotic options marketplace for NFTs (ERC721s) and tokens (ETH and ERC20s). In it, users can create buy and sell side limit orders for put and call options on an asset or a basket of assets. This different approach to NFT derivates offers users an interesting investing opportunity.
What’s Next for NFT Financialization?
While most approaches are still quite recent, we can expect these existing verticals to mature and reach retail users. With a projection for the NFT market size to reach $211.72 billion by 2030, we can expect NFTs to evolve much further from only being pieces of art, games’ skins, or songs. They will become assets surrounded by financial layers with various investors involved in their potential. Then, with liquidity becoming less of an issue in the NFT ecosystem, more and more enthusiasts might join the market.
The current landscape is going through a wave of innovation with new tools and verticals, making it hard to predict what’s coming. The possibilities for the financialization of NFTs are endless. But what is clear is that understanding the accurate pricing of NFTs, in the present and future, is key to expanding the industry. Thus, more NFT technology around pricing definition, prediction, and speculation is probably at the center of the next chapters of NFT financialization. Adding liquidity to NFTs will probably allow many investment models and tools in the crypto ecosystem to enter the NFT industry. Finally, the financialization of NFTs is already expanding the opportunities of this market and allowing creators to build new and exciting NFT projects.