Unlocking Value Stored in NFTs – An Introduction to NFT Finance

2021 has undoubtedly been the year of Non-Fungible Tokens (NFTs). Like it or not, NFT has come up in some discussion or the other in your social circle – from Thanksgiving dinners to Christmas parties to Zoom calls. Some of you may have received messages from long-lost friends – “Hey, how are you? Long time. Heard you are into cryptos. So what the heck is an NFT?”. Merriam-Webster chose vaccine as word of the year for 2021. Meta came in 10th. If not for COVID, NFT might have also been up there.

If you're an "NFT Bro," you might have gotten this text from someone you know (source)

Everyone from mega-corporations (Pepsi, Nike, Visa, Adidas, Time, etc.) to art institutions (Christie’s, Sotheby’s, Artnet, etc.) to celebrities (Snoop Dogg, Reese Witherspoon, Stephen Curry, Jimmy Fallon, etc.) to tech leaders (Tobias Lütke, Dylan Field, Mark Cuban, Dom Hofmann, Justin Kan, etc.) is dipping their toes into NFTs. Additionally, many notable artists (Beeple, Pak, Damien Hirst, etc.) have also made their foray into this space.

While there are many categories of NFTs, pfp (profile picture) type NFT collections have been in the most focus, with some collections like CryptoPunks and Bored Ape Yacht Club trading for millions of dollars for individual pieces. NFTs have also gone on to create their own subcultures, trends, memes, and even an NFT lingo. Pfp collections have spawned large communities of dedicated HODLers (not a typo).

Last week I joined the Generative Masks community for a photoshoot in Decentraland

After spending a considerable amount of time researching various NFT communities and collections, Rohit and I recently started to explore NFT utilities apart from collectibles and aesthetics, pondering whether NFT use-cases stretched further than just as exclusive club access. For somebody watching from the sidelines, this is a natural question that would come to mind.

A newfound focus on Web3 and metaverses, Web2 v/s Web3 debates, Fear Of Missing Out (FOMO), and an ever-growing attention economy have all led to a frenzy around NFTs. And this has created opinions across the spectrum. On one side, there is the promise of utopia, while on the other side, there is the cult of doomers. So is there a method to the madness? As with most cases, the reality possibly lies somewhere in the middle.

In this article, we explore how some platforms are working on DeFi-based ideas for unlocking the potential of NFTs beyond just HODLing. Welcome to the world of NFT Finance.

IQ Protocol

IQ is a lending and borrowing protocol being built on BSC (Binance Smart Chain) and Polygon (previously, Matic) and will offer the first collateral-less NFT rental solution. The protocol is being developed by PARSIQ, a data and workflow automation platform that connects blockchain activity to traditional Web2 applications in real-time.

IQ is modeled around two founding principles — Life-Time Value (LTV) and Rentability – which are implemented through “renting pools” where the NFT owners can deposit their assets (similar to, say, Uniswap pools).

When a borrower rents an NFT, IQ Protocol will mint an expirable version (or iNFT) which will provide the borrower the same privileges and services as afforded by the original NFT. However, the iNFT will come with a predefined LTV, which determines how much and how long the borrower has access to these privileges.

Once the expiry period is over, the original NFT will be automatically returned to the owner through smart contracts. Since the borrower gets an expirable version instead of the actual NFT, there is a limited chance of default, thereby minimizing counterparty risk.

What sets IQ apart from other NFT renting platforms is that it will allow for collateral-less borrowing of NFTs. Typically, platforms require collateral more than the value of the NFT itself. Not only does this impose a financial barrier for the borrower, but it can also lead to the owner losing the NFT (in exchange for the collateral) if the borrower defaults.

IQ Protocol, on the other hand, will enable users to borrow expensive NFTs at an affordable price by only paying the renting fee, so that they can try the assets over a short period first before committing to full ownership. The platform will go live in Q1 2022.

The LTV and Rentability aspects can be extended as a modular solution for blockchain businesses looking to offer subscriptions. Expirable tokens allow businesses to part with their assets temporarily, which mimics subscription-based commerce. This flexibility was previously not possible. Thus, IQ Protocol has built the picks-and-shovels for a circular economy.

The governance token of the IQ Protocol is $IQT which is also set to launch during Q1 2022 with a total supply of 1 billion. PARSIQ is in the final stages of closing its private fundraising round and has already announced a Whitelist Program for a public sale. Allocations and additional incentives will be provided to liquidity providers and to the most active and constructive community members in various social forums.

reNFT

reNFT is an NFT rental protocol built on Ethereum, which allows NFTs to be rented or borrowed in a trust-free and secure manner. Popular NFT marketplace Rarible is integrated with reNFT’s decentralized protocol.

NFT lenders on reNFT have to specify the daily rent, the NFT collateral price, and the max rental period at the time of lending. These parameters are used to calculate the total rent amount. The borrowers, on their part, have to mention the rent period.

Once a borrower agrees to the terms set by the lender, the total rent price gets deducted from the borrower’s balance, and the NFT is transferred to the borrower with full custody. Smart contracts store the collateral amount and act as escrows during the rental process. Funds are returned to the borrower only upon the successful return of the NFT to the owner. If the borrower is unable to return it within the stipulated duration, the collateral can be claimed by the lender from the reNFT contract.

The collateral can be quite high depending on the actual price of the NFT, which provides very little incentive for a borrower to default. However, in the event an NFT’s price exceeds the collateral after being borrowed, the borrower might try to make a profit by keeping the asset and sacrificing the collateral.

To avoid such scenarios, reNFT has developed integration tools to enable trust-free and collateral-free rentals. These smart contracts will provide a “usage right” that is linked to the original NFT and the terms of borrowing.

The governance token of reNFT is $RENT, which will allow holders to vote on proposals within the reNFT DAO. As part of their roadmap, reNFT plans to directly integrate with other NFT marketplaces such as OpenSea, and expand compatibility to Solana and Polygon. The project is backed by marquee investors like Animoca Brands and Lattice Capital.

In the interest of the readers, it should be mentioned that as per the reNFT website, even though the smart contracts have been thoroughly tested and peer-reviewed, they have not been formally audited yet. Users are hence advised to exercise caution while using the application.

Drops

Drops applies DeFi primitives to NFTs, allowing users to leverage their NFTs to obtain loans and earn yield. It operates on Polygon. Drops’ own fractionalization protocol can create NFT renting pools, whereby users will be able to deposit their assets and mint dNFT tokens - ERC20 tokens which represent the NFT assets and bring fungibility to non-fungible assets. Each NFT project will have its own renting pool.

dNFTs will represent a share of the renting pool. The market value of the dNFT tokens will be tied to the value of the locked NFT. The smart lending contracts employed by Drops have been based on Compound Finance’s smart contracts.

NFT(s) can be redeemed by returning the dNFT tokens (+ fees) to the respective renting pool. However, as per the whitepaper, it seems that it is possible to get a different NFT (from the same collection) on redemption. As per Discord moderators though, the whitepaper is slated for an update. So this might change in the future. We will have to wait for the mainnet to go live to understand how dNFT redemption through pools will work.

Alternatively, users can lock up their NFT assets without depositing them to the renting pool. This ensures that, on redemption, they will receive the exact same NFT that was deposited originally. In this case, a fee of 0.2% of the minted dNFT tokens has to be paid as premium each day the NFT is locked.

The contracts are currently being audited by Peckshield. So it is best to exercise caution while using the dApp at this moment. Mainnet launch is planned after the completion of a successful audit.

$DOP, the utility token of the Drops ecosystem, has a total supply of 15 million. The token can be used to trade NFTs on the platform and to pay yield and cashback rewards to users. $DOP will also be used for platform governance.

The above three platforms are not the only ones that are pushing the boundaries of NFT Finance. There are also others like NFTfi, NFTX, Fractional, and many more. However, these are still early days for (DeFi x NFTs). Some of these projects are unaudited. Some of them are starting to find their niche.

While 2021 has seen the explosion of NFT collections, 2022 will possibly start to see their value being leveraged to deliver financial solutions. Something similar is happening in the world of Play-to-Earn games with the advent of GameFi. Likewise, new platforms will present NFT Finance in ways we haven’t seen before.

Share with us your experiences in this area as well. If you’re up for a chat, Rohit and I are available on Telegram.

Disclosure: The authors have no vested interest in any of the projects mentioned in the article. They do not own tokens of IQ Protocol, reNFT, or Drops. None of the information mentioned above should be considered as financial advice.

About the Authors:

Rohit Chatterjee is an Analog Design Engineer working at Texas Instruments. Abhijoy Sarkar is a banker-turned-entrepreneur. They are high school friends who lost contact years ago. They reunited over crypto in early 2018 and have been investing through mutual research and shared knowledge.