Mar 14
NFT Collaterization and How it Works.
Firstly to Understand the principles of Collaterization, we have to understand what NFTs are. Non-Fugible Tokens commonly known as NFTs, are a subset of cryptocurrency assets that can’t be replicated or replaced.
They’ve become a controversial topic, thanks to recent Publications of Digital art works selling for insane amounts of money.
At this stage you might begin to ponder, how does an NFT which are mostly illiquid assets and are not divisible unlike other common Cryptos we know, become Collaterized?.
Simple, by Merging Decentralized Finance with NFTs, a whole new economy for this emerging class of crypto assets is opened Up. In this Brief write-up, We are going to help you Understand the concept of how NFT Collaterization Works. (NFT Collaterization is also commonly referred to as NFT Loans)
What is NFT Collaterization?
Collaterization is the process in whih NFT owners to mortgage their illiquid NFT assets in exchange for stablecoins or Governance tokens.
NFTs can be used to represent ownership of a wide variety of real world items and digital assets, ranging from virtual real estate and collectibles, to digital Artworks and PFPs.
By contrast, crypto is divisible, which means potential investors don’t have to buy one whole Coin/Token in its entirety, but can instead decide to buy fractions at a time. Whilst, all NFTs have a unique digital identifier that ensures they can’t be copied or subdivided. and its Originality can easily be verified on the blockchain, making this one of the biggest selling points of NFTs.
NFTs’ lack of fungibility is great for establishing the uniqueness of assets, however, non-fungibility isn’t without its flaws. The most noticeable flaw is that it limits what investors can do with their NFTs, which makes NFTs highly illiquid. Once an investor obtains an NFT, the most sought after option to turn a profit is to sell once its value increases. This process is known as Flipping.
That’s where NFT collaterization comes in. NFT-backed loans and fractionalized NFT ownership through Decentralized finance protocols are becoming a way to solve the NFT illiquidity problem. These innovations create a market where NFT owners can mortgage their illiquid NFTs in exchange for liquid assets without the potential risk of losing their assets, if a repayment is made on time.
NFT-backed loans enable holders to acquire funds using their illiquid assets as collateral. The loan can then be used to buy more NFTs, purchase tokens that can be converted into fiat, Trade on Defi Platforms or acquire other tokens that can be deployed into DeFi protocols for yields to generate income.
Decentralized Finance mechanisms such as fractionalized assets, collateralized lending, NFT staking, and others are giving collectors new ways to leverage their NFTs beyond passive buy-and-hold or Flipping strategies.
Defi Lending in its entirety is powered by smart contracts, which serve as the bases for transparent, open and self-executing loan solutions which don’t require external supervision.
However, the smart contracts used by DeFi platforms aren’t flawless. Attackers can exploit the market as they take out a loan, driving the value of the borrowed token down, They in turn buy back the token at a lower price, repay the loan and pocket the difference. This proess is called Flashloans.
Regardless of these hurdles, NFT loans are slowly gaining exposure to the mainstream crypto market. The NFT ecosystem is currently underdeveloped, likely due to its age and the size of the market, but expanding its use case in sectors like borrowing, staking and fractionalized ownership would yield a major growth into the industry.
How Does NFT Collaterization Work?
A Platforms that supports NFT collaerization would allow it’s holders to borrow funds and set terms without an intermediary. These Borrowers can expect to get a loan amount of 30–60% of the value of the NFT, with interest rates ranging from 5-80%, depending on the popularity of the NFT.
The beauty of DeFi protocols is how simple, transparent and fast they are compared to traditional lending institutions. There is no centralized authority that needs to check your credit , verify your real identity or wait Ages to hear a feedback from a lender.
Assets that function as collateral are sent to a secure smart contract, which acts as an impartial, automated third party programmed to facilitate the lending and borrowing process.
Lenders would decide what they think is a nominal fair value of the asset, usually by looking at the asset’s sales History or Floor Price. Once both parties agree on terms, the assets woud be transferred from the borrower’s wallet into an escrow vault.
It sounds simple and clean in theory, but the market isn’t entirely risk-free. If the borrower can’t repay the loan and interest by the end of the loan period, then the lender is entitled to the gaining ownership over the leveraged NFT.
What Is NFT Fractionalization?
NFTs are completely unique, indivisible and verifiable, guaranteeing absolute ownership. That means only one owner can fully possess one NFT. Fractionalization of NFTs is a proess which allows multiple individuals to own parts of a single NFT.
Some NFTs are extremely high-priced, and out of reach to certain retail investors. Fractionalization is a convenient way for several parties to each invest a smaller sum of money to gain fractional ownership of the asset.
A Notable Protocol that Offers Fractionalization is NFTX.
In Our Next Article we would be Speaking About The Ragnar Protcol and it’s Art subsidiary SmolDeers and How it would utilize Collaterization in the ecosystem its being built on.
Mugiwara-Odin.
