In 2021, a growing interest in speculation and gambling sparked a multi-billion-dollar wave of liquidity into NFTs. Fast forward two years and the market has plummeted by over 80%. Most projects now have no value and the majority of trading volume is concentrated within the Top 10 NFT collections.
The 2021 NFT user base can be deconstructed into three distinct groups. The first group comprises the majority of users who have left NFTs and the Crypto Market over the past two years. The second group consists of NFT traders and buyers who have temporarily withdrawn from the asset class but continue to maintain their crypto investments, waiting for an opportunity to re-enter the NFT space. The third and smallest group is made up of individuals mostly defined as “degens” who continue to buy, hold and trade NFTs.
Data is showing the emergence of a fourth group that not only incorporates users from the second and third groups but also has managed to attract DeFi enthusiasts and crypto holders.
Converging Styles
One of the biggest problems with NFTs has always been their lack of liquidity. Trading platforms like Blur (ETH) and Tensor (SOL) have created mechanisms such as AMMs to create a more liquid trading experience. In practice, AMMs are not enough for users for the simple reason that NFTs are part of a social layer, thus there are emotions attached to them. Users generally do not want to sell their favourite NFTs, but they do want to have more liquidity for other purposes.
This is a problem that NFT DeFi fixed with the introduction of NFT-collateralized loans. NFT DeFi represents the intersection of decentralized finance (DeFi) and non-fungible tokens (NFTs), incorporating DeFi principles and strategies into the NFT Ecosystem. One of the first use cases is the introduction of NFT-collateralized loans, enabling users to borrow dollars or native crypto while using their NFT as collateral.
NFT users are well aware of the risks of their strategies and actions, so they are more than happy to able to access instant liquidity at a theoretically small cost, to protect the underlying value of their assets or to use the liquidity to invest elsewhere.
DeFi yield farmers and power users see a potentially profitable operation in these protocols, as most look for yield where it can be collected, no matter where it is. If executed properly with strict control over foreclosure rates, NFT lending can yield anywhere from 100%-400% APY, which is very appealing for anyone looking to collect extra yield.
While crypto holders are typically less prone to being exposed to risk, the high-yield environment of this market may pique their interest in allocating a portion of their portfolio.
Lending Risks and Challenges
NFT lending is still in its nascent stages, resulting in elevated risks for both lenders and borrowers. Most of the platforms lack liquidation mechanisms for situations where the collateral’s value deteriorates to unhealthy levels. To counter the significant increase in risk compared with more traditional methods of lending, the APYs are generally multiples higher and in some cases reach 400%.
The surging demand for lending money to these platforms has increased the risk of liquidation cascades. The highly competitive environment of lending order books has pushed LTVs to near 100% levels, meaning that lenders are loaning their crypto with little to no buffer for NFT floor-price drops.
This is particularly risky as non-fungible tokens are already a highly volatile, illiquid asset class which typically sees enhanced volatility. If, or when an NFT drops to unhealthy price levels, borrowers will be incentivized to not repay their loans, as they have virtually received a risk-free loan at almost 100% LTV. As this happens, lenders foreclose the loans at expiration, receiving the collateral NFT and liquidating it as soon as possible to avoid further losses.
Considering that a single foreclosure can erase weeks of compounding yields from successful repayments, the average loan foreclosure rate of 5% might be too much for most investors to digest. Not only do lenders need to avoid foreclosures, but they must also be knowledgeable of the NFT market as each collection has its independent price curve.
Taking into account the risks of lending money to NFT holders, it wouldn’t be unwise to assume the bear market had a significantly negative effect on this niche segment. It turns out that not only the lending ecosystem is alive, but it is thriving and has grown exponentially since the bull market topped.
Usage
Although brutal, the bear market washes away bad actors and protocols. When a narrative appears and thrives in the middle of the most difficult part of the market cycle, one should pay attention. The NFT lending narrative started on the Ethereum blockchain in early 2021. However, it was only after the last cycle’s top that volume and competition started ramping up. In 2023, the number of unique daily borrowers across all Ethereum platforms doubled, mainly due to the growth of Blur and its farming incentives.
Growth and Product-Market Fit breed competition. In December 2022, there were two main lending protocols on Ethereum: NFTFi and Arcade. The success of these protocols and the NFT lending narrative have led to an increase in competition, with the launch of dozens more projects looking to grab market share. Today, the market share distribution looks very different from two years ago, with protocols like BendDAo and Blur sharing a similar market cap as Parax and Arcade, which used to hold 100%.
On the second biggest NFT ecosystem in crypto, lending is proportionally stronger and it has seen bigger growth than expected. Not only is lending rising in popularity, it is now an integral part of the NFT ecosystem. The Solana lending market is controlled by two platforms owning 89% of the market share, Sharky and Citrus.
In September 2023, while the NFT trading volume settled at 1.1M SOL, the NFT DeFi ecosystem closed in at 820K SOL Volume. This allows us to conclude that the NFT lending ecosystem is resilient and very alive on Solana. For every $100 of volume in the NFT market, $43 was coming from lending platforms. This is a staggering growth considering that the first platform launched a little over a year ago.
Today, Sharky alone has on average double the number of loan requests than the entirety of the Ethereum NFT market and a slightly higher number of daily active wallets.
Solana’s fast, low-cost and scalable nature has created the conditions for this narrative to thrive beyond expectations. This paired with very high yields and gamification of rewards has created a recipe that translated into high user retention, high volume and growth.
Conclusion
NFT Lending is expected to grow exponentially in the bull run, and it may even grow beyond the size of NFT Trading, particularly in smaller NFT ecosystems like Solana.
