Introduction

After NFTs became popular in 2021, the value of the entire NFT market reached $40 billion, an all-time high. Starting from the second quarter of 2022, the whole crypto market has undergone volatility in a bear market.

Now in the last quarter of 2022, looking back at the market development over the past two years, we can see that the DeFi and NFT markets have gone through a prosperous period successively. Though this momentum slowed overall which is influenced by the crypto winter in 2022, it has been proved that DeFi and NFT, thanks to the market combining DeFi and NFT which has paved the way and produced a great effect, are new development paths that have been explored by lots of market participants and could be further explored.

Source: Dune@niftytable

During this period, the NFTFi application scenario generated by the integration of DeFi and NFT is remarkable and has become an attractive trend.

NFTFi provides multiple different branches and development directions, including NFT fragmentation, NFT rentals, NFT derivatives, NFT lending, and NFT crowdfunding. This article will introduce what they are, their advantages and disadvantages, and present the corresponding cases for reference.

The combination of NFT and DeFi

Before NFTs were introduced, major DeFi protocols were designed by imitating traditional financial products. However, with the combination of NFT, a series of new financial products with greater potential came into being.

For example, some lending protocols now allow users to stake NFTs as loan collateral. Thus, both lenders and borrowers are able to use NFTs as an alternative to loans backed by more traditional stablecoins or cryptocurrencies in DeFi. In any case, the project combining NFT and DeFi will provide a corresponding product by taking advantage of each technology. Obviously, these products are more flexible than the products in previous DeFi projects and make users more willing to participate.

In practice, the field integrating DeFi and NFT will grow increasingly entertaining and dynamic. It will be an absorbing project with new gameplay for users while an area to be explored but with good development prospects for project teams.

However, in terms of the market situation, some projects seem to be more willing to adapt to the DeFi gameplay by increasing the proportion of NFT attributes. For example, with liquidity pools and decentralization agreements, NFT holders are able to obtain the liquidity of their holdings while undercapitalized investors can take the opportunity to exchange for high-value tokens. There are also other project parties that emphasize the use of NFT-based assets to enhance the DeFi model. The pledge-oriented lock-up approach facilitates the holding of NFT, as well as the issuance and circulation of tokens.

However, no matter what kind of elements are added and applied, the combination of NFT and DeFi has brought rich design materials to the content of many new projects. It is the playability and variability of NFT that have brought about more complex changes to DeFi’s attributes which are intrinsically financially biased. On this basis, it provides users and projects with a stronger anti-risk mechanism.

This is NFTFi. Let’s introduce the major branches it involves one by one.

NFT Fragmentation

NFT fragmentation refers to the process of sharing NFT ownership through a set of fungible tokens related to the original NFT. The NFT is placed in a vault to be fragmented, and then it is minted to be an ERC-20 token representing ownership of the NFT. Each ERC-20 token represents an ownership share of the original NFT.

It sounds like locking a delicious freshly cooked steak in a glass case and then giving each diner a certificate of ownership stating their share of the steak. Certainly, if the steak is kept for a long time, it will lose its value after it turns bad, but NFT will always exist.

Seriously, with NFT fragmentation, common investors can also have access to expensive NFT collectibles, increasing the liquidity in the market. This is because expensive NFTs can be split into their share of value using fungible tokens. After all, it is possible that people will think it loses its value if a high-priced NFT worth millions of dollars cannot be circulated for a long time.

Actually, NFT fragmentation may not always be as good as imagined in practical applications. Reassembling NFT is not easy for this process. To remove the entire NFT from the vault, all holders must sell their tokens, which means that if they cannot all hold the corresponding tokens generated by an NFT fragmentation, then no one will really hold this NFT completely.

Examples: NFTX、Unic

Generally, projects that give access to NFT decentralization services all exist in the form of platforms. Decentralization is actually a process of recasting an NFT, aiming to promote the circulation of this NFT.

Unic.ly allows users to collect a wallet to deposit the NFT in a vault, and mint new ERC-20 tokens (uTokens), thus categorizing NFTs. Unic.ly also has its own DEX where uTokens can be traded. Unic.ly has mechanisms that ensure sufficient liquidity of uTokens pools. uTokens can also be whitelisted if the value of a collection is high enough. LP token holders of the whitelist series can stake their LP tokens to earn$UNIC, UNIC.ly’s governance token.

NFTX.io is an NFT marketplace platform. It allows users to vault their NFTs to create fungible ERC-20 tokens (vTokens). Newly minted tokens can be claimed 1:1 against any random NFT in the vault. Users can pool ERC-20 tokens in automated market makers (AMMs), such as SushiSwap, to create liquidity.

NFT Rentals

Blue-chip NFT projects, such as BAYC or Cryptopunks, are major NFT projects. Their prices are also prohibitive. Similar to NFT fragmentation, NFT rental is also a way to solve the problem of NFT circulation cost. However, it is implemented in a more common way of thinking and form in real life.

Source: Axie Infinity

Just like renting a car or a house, NFT rental provides individuals with the opportunity to use NFT within a limited period of time. Similar ideas are even applied in GameFi such as Zed Run and Axie Infinity, but the application in chain games, which is more about design, must be consistent with the gameplay in the game. However, it is not considered a mainstream form of NFT rental, although their basic logic is allowing users to provide NFT for rental to obtain income.

NFT rentals can be divided into two forms:

Secured leases

NFT owners list their assets for rental on the lease market, and willing lessees can initiate the corresponding lease process. We called this process secured leases.

In this process, the borrower and lender will determine the corresponding terms and conditions for the NFT and then sign a smart contract. These conditions include rent and collateral. And it is also required in the conditions that a higher price than NFTs is necessary to protect lenders. At the maturity of the contract, the NFT and collateral are returned to their original owners.

The conditions of secured leases are the same as the lending agreements adopted in regular DeFi: potential lessees can obtain the non-financial assets they want to borrow by providing collateral at a higher price than the NFT they want, and the borrower can access the NFT within the time period specified by the NFT holder and the coded smart contract bound to the NFT.

Unsecured leases

The key difference between an unsecured lease and a secured lease is that in unsecured leases, after paying the rent, the lessee will never receive the original NFT. Actually, an unsecured lease separates the ownership of the NFT from the right to use the NFT. It only leases out the right to use the NFT.

In 2022, the ERC-4907 protocol standard was created and launched to support NFT unsecured leases. NFTs minted based on this standard can be directly distinguished between ownership and use rights. Intuitively, when minting an NFT, the user can receive an NFT of the ownership token and an NFT of the usage token. However, ERC-4907 is new. Before it came into being, most NFT unsecured leases made wrapped NFTs to clarify the right to lease the original NFT and burned it after expiration.

Platforms offering unsecured leases allow lenders to deposit their NFTs and make wrappers. Once the user rents the NFT and pays the rental fee, the lessee will receive a wrapped version of the NFT, enjoying the same utility as the original NFT. After the contract expires, the wrapped NFT will be burned and the rent will be sent to the lender. An unsecured lease minimizes risk for both parties because the lessee does not need to provide collateral and it is also unnecessary for the lender to lease out its original assets.

NFT rentals provide a convenient way for NFT holders to earn income from the NFT they hold without worrying about the need to split NFT like fragmentation. At present when the NFT rental cases are increasing, NFT rentals will be more and more used in NFT galleries and digital museums, which explores an excellent path for the circulation and application of NFT.

Whereas, many ideas that should have been perfect often encountered accidents when they were put into practice. As a cutting-edge business model in the NFT world, NFT rentals have certain loopholes themselves. One of the related incidents happened during the ApeCoin airdrop for BAYC holders when an unidentified user leased 5 BAYC NFTs through a loan prior to the airdrop. Because of this, the holder’s wallet was eligible for the ApeCoin airdrop, and he earned $800,000 thanks to this bug. Subsequently, rental platforms have patched this loophole.

Examples: IQ Protocol, Vera

Services provided by most NFT rental platforms are basically similar, including a basic menu to browse different NFTs, and creating wrapped NFTs or publishing corresponding collateral information. What’s necessary is to connect users’ wallets.

Presently, IQ Protocol and Vera are the largest NFT rental platforms in the crypto market, and reNFT is the largest unsecured lease platform. Both IQ Protocol and reNFT have not taken NFT rental services as their main business. Vera currently only has a small number of NFTs listed for lease. Therefore, it is necessary to further observe more NFT information to figure out the market.

NFT Derivatives

NFT derivatives are one of the latest branches of NFTFi in its growth. Similar to non-NFT derivatives, derivatives in the NFT field also represent tradable contracts that allow people to bid for the price of NFT in the future. Of course, to make it clear, NFT derivatives are indeed not quite like a real exploration of NFT, but more like simply replacing the underlying assets in DeFi with NFT. However, it is indeed one of the growing paths created by the influence of NFTFi.

NFT derivatives have played a big role in enhancing the liquidity of NFT transactions. It allows people to witness many possibilities, such as trading high-value NFTs, and even using leverage to trade NFTs. Users can also trade in any direction of NFT price movement.

The traditional financial market of derivatives, for example, is far larger than the actual spot market, and the valuation of derivatives reaches hundreds of trillions of dollars. By the same token, this also presents the market growth potential of NFT derivatives, especially when the current NFT market of more than $10 billion is treated as a spot market.

Nevertheless, NFT derivatives are more of an imagination about the future at this stage. After all, we all know how high the value of the contract is, but at present, transactions of NFT derivatives are still in their infancy. That’s why the NFT series that can be used for derivative trading are few. Meanwhile, compared with other derivative transactions, NFT derivatives are extremely risky, especially the magnified losses caused by leverage. Though this also indicates high returns, it is only hard for the market at the initial stage to allow NFT derivatives to do too many trial-and-error experiments.

Cases: NFTures, Fuku

NFTure, a product of Synfutures, is the most well-known platform offering NFT derivatives trading services. Currently, the platform is incomplete and there is only one Cryptopunks NFT available for investment.

Fuku is another company that pioneered the field of NFT derivatives. It will create the first NFT market where options trading is available. Any user can buy and write options of any NFT in the market, instead of restricting transactions to specific NFTs. This means that the market will have 80 million NFTs divided into over 2 million series.

Fuku allows consumers to write and buy options on it, extending NFTFi trading beyond blue-chip NFTs. In addition, to call and put options, Fuku offers a variety of trading services such as limit orders, and has the ability to bid on multiple NFT derivatives using the same collateral. Tokenized options can also be resold on secondary markets, which expands Fuku’s reach.

On Fuku, no gas is charged on writing options because the actions outside the transaction are off-chain. Gas fees are paid only when buyers and sellers agree to a transaction, and transactions are tokenized as ERC-721 non-fungible tokens. All this makes Fuku different from conventional platforms.

NFT lending

Currently, there are three emerging lending forms in the NFTFi space.

P2P NFT lending

P2P NFT lending is a development branch that is on the rise. Similar to DeFi lending projects, P2P NFT lending is usually signed on the chain through smart contracts that include assets, liquidity (loaning), and terms and conditions of lending. The P2P NFT lending platform connects potential borrowers and lenders through peer-to-peer protocols, enabling NFT to be used as collateral to establish a lending relationship between the two parties.

NFT lending CDP(Collateralized Debt Position)

Collateral debt positions for NFTs can be created by locking NFT collateral in smart contracts to generate stablecoins. In this case, the collateral will be an NFT, and the loan amount of a CDP is created based on the NFT floor price.

NFT lending pool

The NFT lending pool operates in the same way as the DeFi lending pool. After running for a long period, platforms such as Aave and Compound have utilized the model widely. The NFT lending pool is operating using over-collateralization. Borrowers use NFT as collateral, which allows them to borrow funds at a market value lower than the total value of the collateral and borrow funds using loan fees. These fees will be distributed to the borrower to motivate them to provide liquidity support to the lending pool.

All the above three loan forms provide additional liquidity for the entire NFT ecosystem via NFT borrowing, as well as add economic application scenarios of sufficient depth to NFTs.

NFT holders earn income by providing the NFT they hold, and the income is the borrowing fees paid by borrowers. Borrowers can also take out loans to finance the purchase of new NFT assets. They do so because they can obtain more circulated capital without having to sell their own NFT assets. This is a good way for both borrowers and lenders to make profits, and it can be said to be a typical example of combining NFT and DeFi.

Of course, NFT is not the same as a cryptocurrency whose value can be determined based on a certain anchor. The NFT price that users often see depends on the previous sales price, so one of the disadvantages of NFT lending is that it is hard to price an NFT.

Different NFT lending platforms use different pricing mechanisms, such as simply using the floor price, or the platform’s own pricing standards. The former way may seriously underestimate the value of an NFT, because the floor price represents the lowest value NFT in the same series. To alleviate this problem, most platforms currently only allow certain NFT series to be used as collateral, so as to stabilize the price of collateral provided to lenders in a certain form.

Examples: NFTfi.com, Arcade, UnUniFi, JPEG

NFTfi.com is a famous NFT lending platform of this kind. It allows NFT holders to accept secured wETH and DAI loans, using NFT to obtain the necessary liquidity. NFTfi.com is a peer-to-peer platform that allows NFT holders and liquidity providers to connect through a permissionless smart contract infrastructure. The platform provides lending services for more than 150 NFT series and covers a larger number of customers.

As another popular NFT lending platform, Arcade allows users to wrap multiple NFTs together as collateral for a single loan, which means that users can borrow more than other platforms. Being more flexible, the platform allows loans to be repaid in full at any time.

UnUniFi, an NFT CDP platform, claims to have the most flexible loan-to-value (LTV) among NFTFi. UnUniFi has an internal NFT trading market to collect NFT floor price data, which is used to determine the loan size. UnUniFi has three stablecoins that can be minted and lent.

All debt payments on JPEG have a loan-to-value ratio of 32% like UnUniFi. Since it leaves room for proposing special requirements for DAO, higher or lower ratios are possible. In addition to owning a fixed debt payment, that’s, all loans have a fixed interest rate of 2% at inception, JPEG also allows borrowers to purchase insurance from CDP.

NFT Crowdfunding

NFT crowdfunding came into being in 2022. It is an emerging development direction combining NFT with DeFi. In fact, NFT crowdfunding represents the collective income ownership of copyrighted NFTs.

Everything can be an NFT. In terms of the copyright-related benefits involved in each series of NFT, NFT creators can enjoy the following rights:

1. The right to buy and sell copyrighted NFT.

2. The right to get a profit sharing of NFT derivatives.

The derivatives produced by copyright NFT can correspond with the well-known IP derivatives. Under such a set of copyright NFT rights division rules, obtaining corresponding copyright income by casting NFT is naturally a reasonable way that the crypto market can satisfy.

As a result, NFT crowdfunding, a rising NFT application scenario, appeared. It is also covered by NFTFi. It actually has no essential difference from the conventional NFT casting model. The key difference is that in NFT crowdfunding, a smart contract of the crowdfunding agreement is added during the NFT casting phase. After starting crowdfunding, users can participate by staking USDT or ETH.

There are three general outcomes of crowdfunding:

If the preset subscription quantity is not reached, the USDT or ETH staked by the user participating in the NFT crowdfunding will be returned to the wallet address in the same way.

If the NFT crowdfunding amount reaches the preset subscription quantity but there is no oversubscription, it will be confirmed by dividing the user’s subscription price by the unit price to obtain the quantity. If an oversubscription happens, proceeds will be distributed after deduction according to the proportion of over purchase, and the excess funds will be returned to the wallet address.

After the NFT crowdfunding is successful, it will start to mint derivatives of the NFT. Generally, the derivatives are NFTs, and there is a clear derivative relationship between the two. The generated NFT derivatives will be sent to the user’s address wallet.

Derivatives of NFT can also be traded. Users can design the copyright that can be traded each time, so as to get a partial commission for each transaction. By doing so, the copyright owner can keep earning profits, and it also allows the copyright NFT to be hyped.

Compared with the previous NFT project parties who issue at least one series of NFTs at a time to earn income for the first mint, NFT crowdfunding is cheaper and has an easier way to encourage users participating in crowdfunding to promote the series of NFTs spontaneously. It is also helpful to the establishment of community DAO organizations. Moreover, this form of crowdfunding can well reduce project risks. We can say that it is a good way to develop NFTFi.

Of course, NFT crowdfunding also has obvious shortcomings. In the current crypto market, the form of crowdfunding is becoming increasingly unfriendly to ordinary users. In the early stage of NFT crowdfunding, it requires a lot of exposure to the project and community-building work, whose effects are often unable to compare with those generated by well-known institutions or traffic KOLs. Moreover, participants will waste the time and economic investment if the initial effect is not achieved, which is very likely to occur because participants need to share the initial cost.

However, it can be seen from these characteristics of NFT crowdfunding that it is also a product of the combination of NFT and DeFi, but it is slightly weaker in terms of the unique attributes of the NFTFi field. However, this does not prevent it from attracting more and more crypto users to participate in it. After all, it is a typical decentralized DAO organization project, and there are still many development directions that can be explored.

Examples: NFTStore、PartyBid

NFTStore is a platform for NFT generation and collaborative crowdfunding. NFTStore supports a variety of data sources, including games, images, video, audio, and other categories. NFTStore has been focused on developing and improving artificial intelligence-assisted tools for over 3 years and has become the world’s first NFT tool that applies artificial intelligence to the auxiliary generation of works. NFTStore supports a variety of major public chains and supports the cross-chain transfer of NFT assets.

Known to the public, PartyBid is the latest NFT collection bidding product launched by PartyDAO. Unlike other competing products, it allows anyone to participate without financial requirements or other restrictions. To put it simply, any user can create crowdfunding through PartyBid and participate in designated NFT auctions, which greatly lowers the threshold for ordinary users to participate in sky-high NFT assets.

Potential of NFTFi in the future

NFTFi is becoming one of the most exciting innovations in the crypto market. It solves the liquidity problem faced by NFT and opens NFT to different asset classes for development. It is a financial example accessible to everyone.

Why is there such a varied form? In the final analysis, it has to be traced back to the subdivision of the two crypto fields of NFT and DeFi. NFT adheres to a development logic-everything can be NFT, and DeFi, in essence, is a replica of financial transaction behavior in the crypto market. The former provides broad asset categories which can be expanded, and the latter constructs a complete economic interaction system. Although the NFTFi produced by the combination of the two cannot be called the ultimate form of the crypto field, it does provide the largest exploration boundary for the entire industry so far, and the boundary has not yet reached its upper limit.

When it comes to the most far-reaching and practical impact of NFTFi on the entire crypto space, we can say that it is the promotion and reform of protocol standards.

ERC-721

Compared with the earlier popular ERC-20 protocol which is mostly applicable to token specifications, the ERC-721 protocol appeared later but is more suitable for NFT has more functions, and is more technologically advanced. This protocol is the first standard that Ethereum made for NFT digital assets, and it is used in projects such as CryptoKitties and Decentraland. The ERC-721 standard was created and released by CryptoKitties CTO Dieter Shirley, who is also one of the founders of NFT.

Although ERC-721 currently has fewer use cases than ERC-20, and its functions are still being explored, the advantages of assets under ERC-721—paintings, bonds, houses, or cars—are that they can guarantee the security and convenience of ownership to be transferred, as well as the immutability and transparency of ownership history. In addition, ERC-721 can also facilitate the transaction and management of tracking, trading, and management of real assets.

In addition to ERC-721, the fierce demand brought about by the development of NFTFi has also prompted the growth of another agreement: ERC-1155. The cross-network compatibility feature of ERC-1155 is undoubtedly what the industry urgently needs.

ERC-1155

The outstanding feature of the ERC-1155 protocol is that it is compatible across chains. So far, most crypto assets can only be used on a few major chains. However, the ERC-1155 standard enables crypto assets based on this protocol to be compatible with other ecosystems, thus being able to operate across multiple blockchains, which is what is urgently needed for the growth of the NFTFi field.

Using Enjin tokens to back assets on the chain, ERC-1155 can ensure that all crypto assets created by this method have a guaranteed value. The value can be obtained by using the native “melting” feature in the Enjin wallet, ensuring a more direct capture of tangible value.

Enjin tokens based on the ERC-1155 protocol are very different from traditional tokens and cannot be directly burned. Unless the original developers regularly buy back tokens, these tokens usually remain in circulation. ERC-1155 is positioned as a more specific token standard, because any asset can be created and burned at any given time under this standard, thus bringing scarcity to Enjin tokens. Therefore, under the ERC-1155 protocol, the burning of crypto assets can reduce circulation and increase overall scarcity, which provides a different type of token protocol than traditional options.

Conclusion

NFT has broad prospects. Its value and application on rare collectibles, and its potential to promote digital patents and copyright registration have unlimited possibilities. Along with the introduction of the economic logic with DeFi as the main body, the NFTFi produced by the combination of the DeFi and NFT will be endowed with a complete and comprehensive development framework and economic system on the basis of infinite. Being unknown, it has infinite possibilities and will present reasonable changes.

In 2021, NFT has gradually been accepted by the public, thanks to the use and sharing of various celebrities. However, as an NFT token, it can not only be used to create digital information, but also unlock more application scenarios. Among them, are NFT and NFTFi, which combine DeFi in the direction of Finance, and start to own more growth possibilities.

However, the P2P nature of cryptocurrency itself makes more people directly interpret it as a combination of NFT + DeFi. The core is that NFT can be applied to a variety of scenarios, whether in fragmentation, leasing, derivatives, lending, crowdfunding, or other new directions. There have been lots of projects to promote the development of corresponding fields, such as NFTure, BendDAO, Partybid, etc. If readers are curious about them, you can try them with your own NFTs.

Since the development of NFT, its protocol standards have also undergone vicissitudes. Innovations from the early ERC-20 to the subsequent ERC-721, or the newly emerged ERC-1155, are all explorations of NFTFi in different directions. It also demonstrates that the industry always adopts a positive attitude toward new things while developing rapidly. Therefore, the exploration and development of NFTFi will become the best footnote in creating a new era in the future crypto space.