- As the cryptocurrency is mired in bearish sentiment, NFTs buck the trend amid widespread adoption.
- NFT-backed loans, which allow holders to use NFTs as collateral, are also becoming more popular.
- Gabe Frank from Arcade shares the steps to borrow against NFTs and how traders use the loans.
After the recent decline in performance, the cryptocurrency is shrouded in a haze of bearish sentiment and uncertainty. Some investors are anticipating a further sharp decline, while others are eyeing the $100,000 bitcoin price target once again.
But the non-fungible tokens, once called a digital fad, have continued to gain momentum on the back of rising sales and mainstream adoption. In 2021, the NFTs market swelled to $41 billion in value, compared to about $50 billion in sales in the traditional art market in 2020.
The rapid growth of NFTs shows no signs of slowing in 2022. OpenSea, the largest market for NFT, this week raised $300 million in a Series C funding round that raised its valuation 800% to $13.3 billion from $1.5 billion in July 2021. Electronics giant Samsung said it will integrate the NFT platform into smart TVs later this year. Recently, The Wall Street Journal reported that GameStop is launching an NFT unit that has hired 20 people for it.
Meanwhile, prices for some of the so-called rare or premium NFTs continue to rise, with the recent Mega Mutant Serum NFT coming out. Sold for $5.8 million.
As the boom in digital holdings continues, some investors and entrepreneurs have found a new way to extract maximum value from their NFT holdings – using them as collateral for loans.
NFT-backed loans solve the problem that most digital holdings are illiquid despite their rapid appreciation, according to Gaby Frank, co-founder of the decentralized NFT lending marketplace.
“We have always seen NFTs as a new asset class,” he said in an interview. “And for it to be a new asset class, you have to have credit markets.”
How to get loans against your NFTs
Cryptocurrency users get loans backed by NFT for various reasons. Some use the money to make more NFTs that are undervalued, and others engage in a decentralized financing strategy called yield farming, which can generate higher returns than interest on loans, according to Frank.
To get started with an Arcade game, users need a Web3 wallet where their NFT collectibles are kept. After connecting to the decentralized application via their wallet and giving the company their token identifiers, Arcade’s corporate OTC office will evaluate the assets based on metrics including recent sales and recent transaction activity. Then, the appraisal report will be submitted to the lenders and borrowers.
“It helps them access the terms of the loan. Essentially, the blockchain is the loan terms sheet,” he explained. “Once you select those numbers in terms of term, financing currency and financing amount, then they can just log into the site. A few clicks and settle the loan.”
These loans are mostly funded with stablecoins of US Dollars (USDC) and Ethereum (ETH). They are non-recourse term loans, which means that if the borrower defaults on the loan, the lender can claim the principal. For example, The Block reported last year that an NFT owner used one of the NFTs as collateral for a 3.5 ETH loan but was unable to repay the loan at the end of the term. As a result, the lender took their NFT, which rose to $340,000 over the term of the loan.
Meanwhile, if the NFT suddenly drops in value and the borrower is unable to repay, the lender will remain stuck with the asset as well.
Frank said the institutional lenders his company operates generally charge anywhere from a 15% to 20% APR on these NFT-backed loans. For example, the bored golden monkey brought the borrower a three-month loan of $850,000 at a rate of about 15% on the platform, he said.
How to choose high-quality projects
Arcade is certainly not the only player in the NFT-backed loan market.
In October, a $1.42 million loan was approved for NFT Autoglyph #488 on the NFTfi lending protocol in what was by far the largest NFT-backed loan ever, according to The Defiant.
Similarly, Nexo has loaned a partnership with hedge fund Three Arrows Capital to allow clients to borrow stablecoins and other digital currencies using NFTs as collateral. Crypto Exchange Kraken is also operating in a marketplace where clients can get loans backed by NFTs.
However, as the financialization of NFT continues, scams and scams can also follow as bad actors leap into space. As a result, the ability to separate wheat from the ragged may be more important than ever.
“It is possible that 95% to 98% of the NFTs are not valuable,” Frank said. “So it’s hard to view it as a speculative investment because most of it will go to zero.”
Rather than indulging in choosing NFTs as investments, Frank follows a simple axiom that he also applies to buying physical art – “buy what you want.”
Additionally, it tracks metrics such as the artist’s social media, the supply and demand dynamics of the group, and whether the project consistently provides value to NFT owners. Among his favorite digital artists are Beeple, Pak, and FEWOCiOUS.