NFT Lending—How Does it Work? Borrowing against one’s NFT holdings is possible through NFT lending. It has become more popular for investors to gain access to borrowing and liquidity. In addition to being a component of NFT loans and other decentralized finance (DeFi) arrangements, nonfungible tokens (NFTs) can be purchased, sold, kept, and traded. A contributing factor to the increased demand for NFT lending is that NFTs are not readily usable in other DeFi sectors due to their nonfungible or unique nature. While investors can stake and yield farm fungible cryptocurrencies, they cannot do the same with NFTs.
The NFT market is less liquid when contrasted with cryptocurrency markets such as Bitcoin (BTC). The reason is that NFTs can be one-of-a-kind, and it might be a lengthy process for an NFT owner to locate a buyer.
NFT loans make borrowing money, diversifying investments, and accessing liquidity possible. Nevertheless, there are dangers associated with NFT loans due to factors such as market volatility and regulatory uncertainty. Various forms of NFT lending exist:
Peer-to-peer NFT lending
A user of a peer-to-peer NFT lending platform can solicit loan offers from other users by listing their NFT as collateral.
Peer-to-protocol NFT lending
A user of a peer-to-peer NFT lending platform can solicit loan offers from other users by listing their NFT as collateral.
Nonfungible debt position
Here, a platform or service provider creates a one-of-a-kind asset on the blockchain to stand in for a nonfungible debt position (NFDP), a record of a transparent loan agreement like MakerDAO’s collateralized debt position (CDP), which lets users swap Ether (ETH) for Dai (DAI), an NFDP can also be traded.
NFT rentals
For the duration of a “tenancy,” users can use the privileges and benefits given by NFTs by transferring assets from their wallets to another user through an NFT rental platform.
How NFT Lending Works
DeFi platforms facilitate the lending of NFTs or protocols between peers. When taking out a loan, owners of NFTs can use smart contracts to secure their assets. An NFT marketplace or platform allows owners to publish their NFTs as collateral and get loan offers from lenders through peer-to-peer NFT lending. To assist in determining the fair value of the NFT, the platform may supply valuation tools or market data. If an NFT owner finds a loan offer they like, they can accept it and get the money in their wallet—usually in a stablecoin.
The platform will store the NFT in an escrow smart contract during the loan term. The NFT is returned to the borrower if the principal and interest are paid off before the loan term ends. A typical marketplace fee is a percentage of the loan’s principal. Lenders typically obtain NFTs, which are worth more than the loan value, in the event of a borrower default. Additionally, the lender can retain or sell the NFT to recover their losses.
Different rules apply to peer-to-protocol lending. The owner of the NFT takes out a loan from the lending protocol and locks up the NFT in the smart contracts of the protocol as collateral. Borrowers can access crypto funds using NFT lending platforms because liquidity providers add cryptocurrency to the lending protocol pool.
How NFT Fractionalization and Lending Create Investor Liquidity
Owners can manufacture tokenized fractional NFTs to release liquidity, and additional investors can access high-value NFTs through fractionalization. In most cases, NFTs are indivisible due to their nonfungible nature. They must be purchased or sold in their entirety. However, investors can possess fractions of Bitcoin, called satoshis, while other fungible cryptocurrencies are not divisible.
Now, NFT fractionalization is a part of the NFT loan space. Tokens that are smaller and more easily traded stand in for fractionalized NFTs; each token represents a portion of the original NFT. Tokenized fractional NFTs are another option for nonfungible token holders looking to access liquidity, especially those owning valuable NFTs. As a result, investors who cannot purchase an entire NFT can gain access to these assets and their value.
The goal of both NFT lending and fractionalization is to make NFTs more liquid. In addition, many more people can become investors in NFT loans when NFTs are fractionalized. This can lead to tactics where NFT owners use a combination of fractionalization and lending to access the money in their NFTs.
If an NFT owner needs cash quickly, they can sell their fractionalized shares. They can then use the remaining unfractionalized piece of the NFT as collateral to get a loan in the NFT lending market. This approach allows owners to access more capital than they could through fractionalization or lending alone.
Benefits of NFT Lending
Borrowing NFTs without a credit check is a boon to digital art creators and owners, as it unlocks NFT liquidity. Digital artwork, collectibles, real estate, and other tokenized assets are all fair game for NFTs. Although NFT values range from very low to expensive, some collections contain NFTs that command exorbitant prices. However, there are a plethora of other NFTs with significantly lower valuations.
Accessing liquidity and capital
Without liquidating their NFT holdings, owners can gain access to liquidity through NFT lending. This is one option for investors who need fast access to funds to buy other assets or put them to different uses.
DeFi and digital art
Visual art is created digitally. When it comes to cryptocurrency, NFTs are all the rage. NFT lending provides a bridge between DeFi and digital art. Serious art collectors and curators can use the facility.
Zero credit checks
Digital artwork In the cryptocurrency industry, NFTs have been well-received. NFT lending bridges the gap between digital art and DeFi. This is an excellent chance for serious art collectors and curators.
Risks of NFT Loans
Intelligent contracts are susceptible to assaults, regulatory uncertainty affects the market, and NFT volatility adds risk. Not only are there inherent dangers in cryptocurrency trading in general, but there are also dangers unique to NFT lending.
Volatility
The value of NFTs is volatile, similar to cryptocurrencies. This complicates appraising the value of an NFT to collateralize a loan. If an NFT value falls below the loan value, it could lead to liquidation, where the borrower defaults on the loan, and the NFT is transferred to the lender.
Liquidity
Obtaining liquidity through NFT lending can appeal to NFT holders in situations where NFTs are not selling well. However, because NFTs aren’t very liquid, it could be difficult for the lender and the new owner to get their money back if a borrower defaults.
Smart contracts
There is always the chance that defects or assaults could cause the loss of collateralized NFTs or cash, even though intelligent contracts lock them into lending conditions.
Regulation
Regarding regulations, NFT lending is just as murky as crypto and the DeFi industry. The market and NFT lending’s viability are vulnerable to regulatory changes, which may force stakeholders to adopt or comply with new standards.
As a solution to the problem of NFTs’ low liquidity, NFT lending allows owners to put their assets to work instead of sitting on them and watching them grow in value. Also, verifying transactions on Ethereum can be expensive, and NFT minting can take a lot of energy.
