The Financialization of NFTs

In March 2021, history was made when digital artist Beeple sold an NFT—The First 5000 Days—for close to $70 million at Christie’s Auction House in London. This record-setting sale kicked off an NFT mania, with sales surging from $2.5B in the first quarter of 2021 to $13.7B by the second quarter. Even since then, growth within the NFT space has continued to skyrocket. 

While NFTs have appeal in their own right, they have historically been considered illiquid assets. Increasingly, people want to put their assets to use, and being able to obtain liquidity without selling their NFT is a concept with wide appeal. We have already seen examples of NFTs being tokenized; the next step will be “financializing” those assets using DeFi protocols, transforming NFTs into highly useful assets with increasingly numerous use cases. 

Tokenization of NFTs

The tokenization of NFTs came early on. Shortly after the newsworthy Beeple sale, Metaverse launched B20, an ERC-20 token that essentially fractionalized ownership of the Beeple 20, and unlocked an opportunity for the everyday investor to capture some of the upside on the $2.2 million dollar collection. 

Collector cooperatives and DAOs have let larger groups invest in NFTs that would otherwise be out of reach for the average individual. PleasrDAO, originally formed to purchase pplpleasr's Uniswap V3 NFT, has since evolved into a collective with a reputation for purchasing culturally significant pieces, having already acquired Edward Snowden’s Stay Free and Once Upon a Time in Shaolin by the Wu-Tang Clan. 

Indexes have also emerged, making it easier for investors looking to capitalize on the wave of NFT growth. In April 2021, Index Coop launched their NFT-tracking Metaverse Index (MVI), letting investors gain exposure to tokens including Audius, Axie Infinity, Decentraland, Illuvium, NFTX, Rarible, and more. Even traditional finance is taking note: at the end of November, Horizons ETF Management announced MTAV, the first metaverse index ETF in Canada.

Fractionalized ownership is appealing: not only can you own a piece of something that would otherwise be out of range, but holders are also buying into a community of sorts. With the launch of marketplaces such as NFTX, mainstream NFTs like Mooncats or CryptoPunks were no longer illiquid assets. Now, someone with the underlying tokens could not only capture the upside of these NFTs’ increasing value, they also had multiple options: sell their tokens at the market price, provide liquidity on a decentralized exchange like Uniswap, or even save up enough of the token to eventually exchange it for a floor-price Mooncat or CryptoPunk. 

Financialization of NFTs

The move towards greater liquidity didn’t end with fractionalization—now, the financialization of NFTs is unlocking even more utility for these previously-illiquid assets.

At the end of October 2021, the largest ever NFT-collateralized loan was taken out via NFTFi. $1.4M in funds was lent to the owner of Autoglyph #488, an NFT by Larva Labs, famed producer of CryptoPunks. Although the idea of NFT-backed loans has been proposed before, the sector's recent growth and the size of the loan drew more attention to the concept this time. The quest for increased liquidity is the underlying motive: obtaining a loan by putting up an NFT as collateral can help investors be more capital efficient, perhaps allowing them to divert their borrowed funds into other projects.

In addition to NFTFi, various other protocols have emerged: PWN and Pawn.fi are two other options for collectors wanting to access peer-to-peer loans backed by their digital assets. While each has their unique way of operating, the underlying concept is the same: a unique ERC721 token governs the borrowers and lenders interactions. With this token, the borrower can pay off a loan and reclaim collateral. The lender uses it to receive the loan payoff along with interest, or in cases of default, obtain rights to the borrower’s NFT.

One fact that may be surprising to some people, is that this concept is not unique to crypto. In fact, as of 2019, the global value of art-secured loans was over $21 billion, more than a 40% increase since 2016 (Deloitte). What is different is that the crypto sphere does not have licensed appraisers or pawn shop owners assessing the value of the collateral. Instead, in a space governed by smart contracts, assessing the value of NFTs must be crowdsourced in other ways—for example, through a DAO or a collective of incentivized participants. 

What’s Next

At the beginning of 2020, the DeFi space celebrated $1B in TVL. The rest of the year saw exponential growth, and as new protocols emerged, the DeFi space evolved to include not just dexes and lending protocols, but derivatives, payments, and more. By the third quarter of 2021, the DeFi space had grown to an impressive $107B TVL.

Similarly, unlocking liquidity could be a major catalyst for the NFT market. While the sector has already seen impressive growth, promises of increased capital efficiency and greater utility will very likely position the space for exponential growth.

Already, blockchain gaming is transforming static in-game assets to highly useful, interest-bearing investments. Arguably, this concept isn’t new: OG projects like Cryptokitties, Axie Infinity, and Aavegotchis led the way in forging an intersection between NFTs and DeFi. With Axie Infinity, users can earn tokens, mint NFTs, and sell them. Sandbox also lets gamers monetize digital assets in the virtual worlds they create.

While many of these protocols are still in their early phases, it will be interesting to see how the space evolves. Perhaps there may be opportunities to use multiple NFTs as collateral, making these loans even more accessible to the average investor. Already, we are seeing the possibility of tokenizing real-world assets to maximize liquidity and unlock levels of capital efficiency that were never historically possible. 

NFTs have already captured the world’s attention, so increasing their utility will undoubtedly make them even more attractive in the journey to mainstream adoption.