Getting to Know the Concept of NFT Loans (A Guide)
May 5, 2022
When it comes to understanding the process behind getting an NFT loan, two concepts that are quite important to note are DeFi and NFTs.
DeFi (Decentralized Finance) is a blockchain invention that offers financial services and products to crypto investors without the need to get permission from traditional banks.
With DeFi, anyone can borrow and lend the fiat equivalent in cryptocurrencies without the need to go through a traditional financial intermediary.
When it comes to NFTs, you might be wondering, how then do NFTs serve as loans for interested investors?
Well, it is quite simple. NFTs can serve as collateral for getting a loan just like you would use your property as collateral when getting loans from traditional financial intermediaries.
In this article, we will be taking a look at NFT loans, how they work, and how individuals can maximize the opportunities they bring to the optimum.
Understanding NFT loans
To start with, NFT loans are non-fungible tokens that are owned by certain individuals, which they can use as collateral in exchange for cryptocurrency or fiat. This has been made possible thanks to the existence of DeFi platforms.
To further simplify this, it is important to understand that the NFTs are not the loans themselves but unique assets one must have to serve as an exchange, in turn, for a particular amount of crypto or fiat.
When we talk about NFTs, it is also important to remember that they can be a lot of things to different people. NFTs could be art, digital cards, virtual real estate, or even avatar collections.
This is why they are seen as unique assets by investors or platforms who are willing to grant a crypto or fiat loan to any individual holding them.
Specific examples of these NFTs include the First 5000 Days image collection done by artist Beeple, which sold for $69 million, and Jack Dorsey’s tweet, which sold for $2.9 million.
There are other NFTs out there as well, which have sold for ridiculous prices, justifying the purpose for which they are classified as unique assets.
At first, NFTs are seen as non-fungible, which is the basis for their uniqueness, but at the same time, it is the reason for which they are classified as highly illiquid.
Since they are very illiquid (not easily convertible to cash), it poses a limit on what investors can do with them, which is why the first thing that comes to the mind of any investor is to sell them and make a profit once their value skyrockets.
This issue, nonetheless, may no longer pose a major challenge as NFT-backed loans and fractionalized NFT ownership through DeFi protocols have proven to be the solution to the illiquidity problem.
As such, even though one can’t do much with an NFT, such as staking or otherwise, to generate profit, one ..can sure trade it in as collateral in exchange for loans.
These loans can then be used for a variety of purposes, such as buying more NFTs or buying more tokens that can be put into DeFi protocols to generate profit.
Looking at DeFi
Today, decentralized finance has achieved major feats in the crypto space, especially with the introduction of various financial activities such as lending, renting, staking, and even margin trading.
Thanks to the introduction of these activities, investors can now do more with NFTs than just buy, hold, and sell them when their value increases.
Also, the lending aspect of DeFi is undertaken by smart contracts, which are self-executing programs that serve as the backbone for loan solutions and execution without the need for any guidance.
They simply exist to carry out whatever task or activity that has been assigned to them beforehand, and when successfully executed, individuals get to see them through friendly interfaces just as with any other application.
As much as these smart contracts carry out these tasks, it doesn’t mean that they are flawless, as crypto loan criminals are a constant threat to their performance.
These criminals usually look for ways to exploit the market by taking out a loan, ensuring that the value of the loan drastically reduces, and then buying back the token at a reduced price, repaying the loan, and making a profit from whatever difference is left.
Notwithstanding, DeFi is still doing a good job, and with its merging with NFTs to yield NFT-backed loans, the NFT and crypto space are gradually opening up to the concept of NFT loans.
Given that the NFT market and NFT loans themselves are relatively new, it would take some time for them to achieve full recognition in the crypto space, but one thing is certain: the activities carried out through NFT loans are positively expanding the market.
How NFT loans work
The workings of NFT loans are not as complicated as one might initially think. It simply starts with crypto platforms granting users the ability to borrow loans using NFT at predetermined terms.
For example, some platforms may allow users to borrow a loan worth 70% of the value of the NFT being used as collateral while charging an interest rate dependent on how popular that NFT is.
Note: How popular an NFT is, is a good indication of its value. This means that the greater the popularity of an NFT, the greater the likelihood that the NFT will be valuable, and vice versa.
One major advantage DeFi lending has over traditional institutions is the fact that it cuts out the need for unnecessary bureaucracy before a loan is approved.
With DeFi lending, borrowers do not need to worry about their credit score or other unnecessary documents as the process is very fast and highly transparent.
As has been mentioned earlier, NFT loans work thanks to the existence of smart contracts, which facilitate the whole process quite quickly and, at the same time, give borrowers complete control over their loans.
Borrowers themselves can find out if they are getting a fair loan price for their NFTs by looking at the NFT’s past performance. Another way would be to look at the past floor price or the sales history of other NFTs in the same category.
Once the borrower feels convinced that he is indeed getting a fair price, he can then proceed to make an exchange where he transfers the NFT and, in turn, gets an NFT loan.
There are always caveats attached to these sorts of transactions, especially if the borrower fails to pay back the loan. Once that happens, the lender automatically assumes ownership of the NFT that was used as collateral.
This is simply similar to what is done in traditional institutions where if loan defaulters fail to pay up the borrowed amount, the bank seizes the assets they put down as collateral until the loan is settled.
What platforms offer the best NFT loans?
Now that we have looked at what NFT loans are and how they work, it is also important to know the platforms that offer the best NFT loans.
This information is crucial to ensure that users get the best offer for their NFT if they decide to take an NFT loan.
Let us take a look at some of them below:
Nexo is an incredible platform for NFT loans because it allows users to borrow up to 20% of the value of their Bored Ape Yacht Club (BAYC) or CryptoPunks without having to sell them.
To get started, users only need to use the form on the page, get a quote that will be created by the user’s account manager, and then sign the lending agreement and receive funds in no time.
Keep in mind, though, that you can only apply for a loan on Nexo if the value of the NFT you want to use as collateral exceeds $500,000.
Arcade is another amazing platform that was built on the Pawn Protocol, an infrastructure layer for NFT liquidity that enables the financialization of non-fungible tokens (NFTs).
On Arcade, borrowers can make loan requests, setting terms such as type of funding cryptocurrency (ERC-20), loan duration, and interest percentage, for term loans of at least one day in duration, collateralized by their wNFT.
NFTfi is a platform that users would find quite interesting. All they simply need to do is list their NFT as collateral and get loan offers from users on the platform.
Once users accept an offer, they receive wETH or DAI liquidity from the lender’s wallet into theirs, and their NFT gets transferred into a double-audited escrow smart contract for the loan duration.
Borrowers must also endeavor to repay the loan before it expires, after which they get their NFT back.
On the other hand, if they default, the lender will foreclose and receive their NFT.
NFT loans are a major upgrade from the traditional loans we are used to being accustomed to.
Thanks to the introduction of the DeFi protocol as well as the existence of smart contracts, individuals can now take NFT loans without any hassle, in contrast to traditional financial loans.
Right now, NFT loans may not be mainstream yet, but it is expected that with the kind of opportunity it brings, it will only be a matter of time before it gains wide acceptance across all markets.
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