How NFT Finance Accelerates NFT Mass Adoption
Stephen Young, Founder & CEO, NFTfi, an NFT collateralized loan marketplace.
There is so much hype around Art and Collectibles (A&C) in the NFT space that you would be forgiven for thinking NFTs begin and end there. Certainly, the vast majority - although not all - of NFT projects to date have been concentrated in A&C. Quarterly studies released by NonFungible paint an interesting picture: by volume, A&C accounted for 91% of the market in Q1 of 2021, down to 85% in Q3. This simultaneously shows the dominance of A&C, while also pointing to the expanding presence of other NFT verticals.
As NFT use cases expand and diversify, the market grows (surpassing USD 40bn in 2021, per Chainalysis), and the technology’s benefits are increasingly recognized, two questions, therefore, remain: what is holding NFTs back from mass adoption and how can we get there?
In a recent article for Cryptonews.com on this topic, Kiril Nikolov suggests that the holdup is partly the low levels of global crypto adoption (only an estimated 106 million people hold cryptoassets), but primarily the lack of utility and services that can make NFTs accessible and useful in people’s everyday lives. One of the key services Nikolov mentions is the development of financial tools.
Motivated by the importance of developing this new frontier, this article proposes that such financial tools can be defined and grouped under the term ‘NFT Finance’. In the following sections, I will break down what NFT Finance entails, suggest a framework for understanding existing and future financial products, and demonstrate how it can enhance an incredibly diverse range of global industries. Most importantly, I will argue that NFT Finance is the key to mainstream NFT adoption and expanding the liquidity and growth of NFT markets, within and beyond A&C.
What is NFT Finance and why does it matter?
First and foremost, let’s look at what NFT Finance entails. In the first article published in the collaborative research series between CadLabs and NFTfi titled ‘The Advent of NFT Finance’, NFT Finance was defined as ‘the Web3 infrastructure and set of markets for NFT-based financial products and services.’ To understand what this means in practice, it is helpful to draw comparisons with the traditional finance (TradFi), A&C, and real estate industries.
In TradFi, the services that take place outside of the main banking system, or that service niche assets, are termed Specialty Finance. In the world of A&C, the financial services that have developed in recent decades, from art investment vehicles to loan providers and securitization platforms, are therefore considered a form of Specialty Finance. The existence of these financial products enables more activity in the A&C market as players free up capital, conduct more complex transactions and participate in new ways beyond a straightforward artwork purchase or sale, particularly in the secondary market. In a similar fashion, the Financialization of real estate in the 1990s, with the creation of mortgage-based products and derivatives and the securitization of loans, was crucial to that industry’s boom.
These comparisons help us to envisage what NFT Finance can offer for NFTs, by creating liquidity and new markets based on NFTs that would hugely broaden the opportunities and scope for investment, value creation, trading, and other forms of market participation.
At this early stage of development and innovation, it is important to think as broadly as possible and, crucially, to consider how NFT Finance can facilitate and enhance the use of NFTs in industries beyond A&C. To do this, however, we first need to establish the suitability and likelihood of such widespread NFT adoption.
The suitability of NFTs for widespread adoption
NFTs can be anything. Any economic activity built around distinct units could therefore benefit from these units existing on a blockchain as NFTs. These benefits, to name a few, include greater transparency, accountability, traceability, efficiency, reliability, and composability. Which industries in particular stand to benefit? To begin with, any that have non-fungible items at their core. Here are a few examples:
Supply chain management: NFTs can authenticate products and ensure quality standards. Thanks to the traceability of NFTs, the origin of products can be verified and their movements can be tracked at each stage of transport and production. This would be a major advantage for any business reliant on supply chains, from food to fashion and pharmaceuticals. The potential impact of enhanced supply chain management across the globe cannot be underestimated.
Patents & intellectual property: NFTs can be used to transfer ownership. Records of patent owners can be held on the blockchain and tokens containing self-executing contracts can transfer the legal rights associated with patents upon token transfer. A notable development in this space is a partnership between IBM and IPwe to create the infrastructure for a global patent marketplace where tokenized patents can be traded via NFTs. The utility of this platform will go further than simple sales transactions, also enabling participants to license, finance, research, and commercialize patents. This is a key indicator of how NFT integration in an existing industry can be enhanced by the creation of additional financial products and systems (NFT Finance) that bring flexibility, liquidity, and efficiency. Expanding on exactly this topic, IPwe CEO Erich Spangenberg said,
"The use of NFTs to represent patents will help create completely new ways to interact with IP. This is expected to benefit not only large enterprises that have significant intellectual property, but it will bring new opportunities to small and medium enterprises and even individual IP owners. We believe it will usher in new offerings by financial services firms and corporations to promote the evolution of a new patent asset class."
Real estate: NFTs are not just fundamental to virtual real estate in the metaverse, but are already being used to facilitate physical transactions. In February 2022, the first NFT-linked house sale took place in the US through Propy, a startup that is combining real estate with NFT lending. In this case, the NFT was linked not to the housing deed but to ownership of the LLC that owns the physical asset. This is just the start of experimentation in this industry, with many potential applications of NFTs now being recognized and the development of DeFi mortgages underway which will doubtless encourage more NFT-based transactions in the space.
The above examples clearly demonstrate how NFT Finance products are developing organically as NFT usage accelerates in non-A&C related industries, and the huge potential for NFT Finance to facilitate broader NFT integration. However, it also highlights the need for further research into and development of the possibilities of NFT Finance in broad terms, rather than on an industry-by-industry basis.
In order to do this, we need a framework for categorizing the main types of NFT Finance infrastructure that can be applied across all industries.
A framework for NFT Finance
In the recently published article series ‘The Advent of NFT Finance’, a framework for categorizing NFT Finance products, based on TradFi market infrastructure, was proposed by Giulio Trichilo and Jonathan Gabler. This categorization is useful not only for grasping the mechanisms of NFT Finance, but it offers a broad framework for understanding and further developing the space. With this in mind, let’s break these down and see how each category works in practice by exploring a number of innovative platforms already in operation.
- Debt-like: the creation of fixed-income instruments that result in a cash flow based on NFTs e.g. a peer-to-peer loan where an NFT is used as collateral.
- Equity-like: the creation of any instrument enabling the ownership of fungible items backed by non-fungibles e.g. fractionalized tokenization of NFTs via ERC20s.
- Aggregation-like: the creation of investment vehicles, aggregators or market-making utilities that enable individuals to become market participants solely on the basis of upfront capital, with no technical knowledge required - such as index tracker funds or an NFT automated market maker.
The majority of debt-like products in existence are lending platforms. Borrowers benefit from liquidity without having to sell their assets, while lenders benefit from a profitable APR (annual percentage rate). Transactions are executed via smart contract and if the borrower defaults, the lender automatically receives the collateralized NFT - the most commonly listed collections include CryptoPunks, Bored Apes, Art Blocks, and VeeFriends, to name a few!
In the equity-like category, we have seen the rise of NFT-based securitization products which enable the part-ownership of non-fungible items. The Particle Collection, for example, is pioneering the collective ownership of traditional blue-chip art - by acquiring paintings which are then sub-divided into 10,000 individual NFTs (or Particles), which can be collected and traded. The first artwork to be Particalized was Banksy’s ‘Love is in the Air’, purchased for USD 12.9m at auction in 2021. The physical work, along with all future acquisitions, will be installed in a forthcoming non-profit Particle Foundation - both physically and in a metaverse museum.
When it comes to aggregation-like instruments, DAO-managed indexes are a thriving example. The Index Cooperative, a DAO (decentralized autonomous organization) currently has over USD 400m in assets under its management with a variety of investment opportunities linked to the crypto space for individuals and institutions. These investment vehicles are being met with sharply rising demand, with the number of index holders at Index Coop alone growing from 5,000 to over 30,000 over the course of 2021.
The value of NFT Finance
NFT Finance is not an accessory to the NFT space, but will prove fundamental for the mass adoption of NFTs beyond the limited sphere of Art & Collectibles. As outlined in this article, NFTs have the ability to enhance industries from supply chain management to real estate - with NFT Finance unlocking new opportunities for individuals and institutions to participate and profit.
Due to the nature of DeFi composability which is unique to blockchain infrastructure (as are NFTs), there is an unprecedented level of interoperability between NFT markets and NFT Finance compared to traditional markets and their respective Financialization.
The potential user base for NFT Finance products is therefore far wider than in traditional Specialty Finance, with the typically decentralized nature of these new products removing further barriers to entry. If NFTs are at the precipice of mass integration and mass participation, NFT Finance will be a decisive factor.
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