Non-fungible tokens ( NFTs ) have gone from niche to mainstream in the past year, with explosive sales volume growth accompanied by innovative use cases for cryptographically unique tokens. Vibrant new communities have sprung up around NFTs linked to sports , digital art , music and film
Yet even as new brands, gaming experiences, and metaverses are being built , the corresponding financial layer remains undeveloped.
This is the realm to watch, and it’s packed with derivative options for NFT fractionalization , lending and much more, said Daniel Yan, founding partner and COO of Matrixport , a Singapore-based financial services platform. with $10 billion of client assets under management.
“With NFT as an asset class, it’s starting to get massive,” Yan told Decrypt.
A liquid future for NFTs
The critical issue of liquidity is the “key” to building the robust financial layer that is integral to the sector’s healthy growth, Yan said. “The liquidity helps the thing grow much faster than you would expect.”
At present, it is still too expensive or difficult to lend and earn interest on a high-value NFT, such as a Bored Ape . But without the means to monetize NFTs, the industry will not be able to deliver on its initial promise.
– Strong competition in the NFT lending space
– NFT rental is key to unlock scalability of metaverses and games
– Aggregators have effective value capture
– Reliable NFT pricing oracle is essential
— Matrixport (@realMatrixport) April 1, 2022
Thus, although the leading market OpenSea negotiates between 50 and 120 million dollars a day, this maturity has not yet been felt in the sector in general. “Everything else is pretty early,” Yan says, noting that the trading volume of fractional NFTs, NFT loans, and leasing is on the order of $1 million a day, or less.
But that is about to change, Yan said, highlighting five verticals that Matrixport has identified as ripe for growth in a recent report on the financial layer for NFTs. These include NFT fractionation, lending, leasing, pricing, and aggregators.
One area with potential to increase trading volume is fractional NFTs. If NFTs are broken into pieces and sold in fractions, they become smaller and more tradable—that is—more liquid.
“There is a natural demand for liquidity that is added somewhere because people can use it to trade and use it as collateral,” Yan explains.
“Fractionation, leasing, and pricing are extremely important to the health of the [NFT] industry.”
— Daniel Yan
It is a corner of the sector that does not lack infrastructure. Among the main players identified by Matrixport is NFTX , whose objective is to fractionate the minimum price of NFTs, the minimum price of the entire group. The project has launched NFT vaults for popular projects, and its CryptoPunks vault has $20 million in Total Value Locked (TVL).
Another project with potential is Fractional.art , which focuses on rare NFTs, along with methods to fractionate and recompose the tokens.
Last June, the art acquisition collective PleasrDAO bought the original NFT of the Doge meme for $4 million. They successfully fractionated it on Fractional.art, and the result was the $DOG token, which reached a market cap of over $500 million within days of launch.
The development of loan protocols lags behind fractionalization, and is divided into two segments.
The first is peer-to-peer (P2P), which lacks liquidity and scalability, and the second consists of liquidity pools, which use floor prices to allow loans using NFTs as collateral. This approach poses problems due to the possible difference in the rarity scores of the different pools. “I’m not sure that’s the solution,” says Yan.
Active projects in this area identified by Matrixport include MetaStreet , which acts as a liquidity provider for P2P NFT lending protocols, and Bridgesplit, an NFT lending protocol based on a Solana liquidity pool .
Borrowers are typically people who own NFTs of relatively reasonable value, and want to be able to access the funds, without selling, because they believe the value will rise.
Meanwhile, lenders are people who want to earn interest. They are happy to take on the risk of these secured NFT loans, and there are many different ways to design them.
NFT rental opportunities fall into two sectors: land in virtual territories like Decentraland , and gaming instruments.
With virtual land selling for millions of dollars , it’s no wonder speculators snap up NFT land to sell. But some prefer to rent—and are happy to pay for premium virtual real estate to build on, or host a club or market and earn money—just like in real life, Yan said.
New use cases, such as NFT booking or subletting, could lead to something akin to an “Airbnb of the metaverse,” according to Matrixport’s analysis. But the rental boom in the metaverse will take time.
Another expanding area of the rental market is play-to-win games like Axie Infinity , in which players battle Pokémon-style monsters represented by NFTs. Through so-called “scholarship” programs , players can rent the popular Axies, with owners earning around 15% of the profits.
It’s an exciting industry, and while it’s not developing fast, “demand and supply will come together naturally with the growth of the metaverse and gaming,” says Yan.
Pricing NFTs is challenging; discrepancies in token prices make it extremely difficult to value them, Yan said. Statistical methods and machine learning are of little use when the main problem is that only a small proportion of a collection of NFTs are traded on any given day, and each day is different, making it difficult to exploit the trading data.
One of the most popular pricing methods is to use a floor price, “but as you can imagine, that’s far from exact,” Yan said.
Still, a reliable approach to NFT pricing is important for the overall sustainability of the sector. “It’s very useful for people to make predictions, trade and essentially attract the knowledgeable institutions and money,” Yan said.
Financial instruments such as loans and leases depend on a very precise and liquid underlying market, which is why many protocols are faced with the question of pricing. Meanwhile, the frequency of laundering operations—a result of low liquidity and the prevalence of P2P—compounds the need to better address the issue.
NFT aggregators combine multiple purchases into a single transaction, offering better prices and liquidity through the aggregation of multiple markets.
They work very similarly to Web2 marketplaces like Kayak and allow buyers to purchase a specific category of NFTs from different marketplaces while minimizing transaction fee costs.
Currently, OpenSea is the dominant market, so aggregators have not yet gained ground. But as the industry starts to grow and users adopt more niche markets, the field will become more competitive, Yan says. This is when aggregators like gem.xyz and genie.xyz will start to really make sense, helping users access better liquidity and pricing.
A solid financial layer
The verticals that make up the financial layer will attract a more diverse group of investors who will provide the liquidity that the sector needs to take advantage of the opportunities that are offered. “At the moment we don’t have that. It’s still a very small group. Most of the people are very good, but the involvement of smart money in this is very limited,” Yan said.
“These primitives are going to take off in the next one or two years.”
Consider that many of the verticals are interconnected and interdependent. “Fractionation, leasing and pricing are extremely important to the health of the sector, for NFT markets to grow, and aggregators and lenders depend on them.”
However, “these primitives are going to take off in the next year or two,” he predicts. Big and ambitious structures are being built, and soon.