What on earth is an NFT loan?
There are two types of NFT loans.
Firstly, using an NFT as collateral to secure a loan. Typically, the amount of money/crypto you can borrow against your NFT collateral is 20% of the collateral’s value, giving your loan an LTV of 20%, and a 500% collateralisation level (your NFT collateral is worth 5x what you have borrowed). The reason for this high level of collateralisation is due to the volatility of NFT values and difficulty in liquidating.
Secondly, borrowing an NFT, also known as NFT renting. NFTs have more use-cases than just digital artworks. Some NFTs are used as keys to access real world venues such as private member’s clubs, find out more at NFKey. Others are used as playable characters or resources in blockchain games, more on that in another blog post.
Benefits of NFT loans
Due to the time taken to sell an NFT, the owners might find themselves in need of extra cash to meet their short-term cash flow needs. By borrowing up to 20% of the value of their NFT, they’re able to effectively meet their short term obligations before they’re able to sell their NFT.
Similarly, NFTs can be very expensive to own outright, which can rule out being able to play certain blockchain games or access real-world clubs. To get around the problem of owning an NFT, one can simply rent it instead - for a fraction of the cost - and simply return the NFT (with interest) to the owner after they’ve finished playing the game or visiting the club. Letting people rent your gaming NFT, and taking interest in the form of a percentage of the player’s in-game earnings, is very popular in Axie Infinity, where this arrangement is known as a Scholarship.
How do NFT loans go wrong?
NFT loan liquidations work in very much the same way as traditional loans.
1 - NFT as collateral: If the borrower fails to repay the amount borrowed plus interest, their NFT collateral is forfeit and liquidated to repay the lender.
2 - NFT as principal: If the borrower fails to repay the borrowed NFT plus interest, their collateral is forfeit and liquidated to repay the lender. In a case where the NFT value rises significantly, this may mean that the lender receives less than the higher value of the NFT.
Given that the market for NFT’s are considerably less liquid than for assets such as Bitcoin and Ethereum which are typically used as collateral for crypto borrowing, Loan-to-Values are likely to be lower.
Where can I get an NFT loan?
These venues are open marketplaces, where owners of NFTs and prospective lenders will submit bids (by the borrowers, how much interest they’re willing to pay) and offers/asks (by the lenders, how much interest they’re willing to receive). If a bid is matched to an offer/ask, then the loan is created and the funds switch hands, where the funds are sent to the borrower and the borrower’s NFT collateral is stored securely in the lending platform.
A popular peer-to-peer venue is NFTfi.
These venues don’t match lenders and borrowers. Instead, the borrower will face-off against a protocol. Each protocol has a distinct set of rules (borrowing criteria) that are dedicated by smart contracts and governed by protocol participants. Protocol participants (lenders) will deposit funds into a liquidity pool, and prospective borrowers using NFT collateral will deposit the NFT within the protocol in order to access funds from the liquidity pool. The NFT collateral is stored securely within the protocol for the duration of the loan. In the event of collateral liquidation, the value of the NFT will be referenced using price oracles which source their pricing data from the largest NFT trading venues such as OpenSea.
NFT owners are able to stake their NFTs in the protocol to earn governance tokens in the protocol, which can be sold (to realise a yield) or used to vote in governance proposals.
A popular peer-to-protocol venue is BendDAO.
3. Non-fungible debt positions
Using these venues, NFT owners convert their NFTs into a synthetic stablecoin called $PUSd, whose value is pegged to 1 $USD. NFT owners can use $PUSd to supply liquidity in the protocol’s liquidity pool and earn interest. They can also sell their $PUSd for any other crypto. Once the $PUSd is repaid, the NFT collateral is returned to the owner, or else it’s liquidated.
NFT owners can create a non-fungible debt position at JPEG’d.
4. NFT Rentals
Using these rental platforms, tenants (borrowers) can borrow NFTs from the NFT owner for a specified time, interest payment and collateral amount, all dedicated by smart contracts. An advantage of this method is rather than the NFT being confined for storage in the venue, it goes directly to the borrower, allowing them to access benefits such as entry into gated Discord servers.
A popular venue for NFT rentals is reNFT.