The NFT DeFi world is evolving as developers find new ways to merge their individual strengths in powerful ways.
after reading this, you'll understand:
DeFi capabilities improve the interoperability and increase the liquidity of NFTs.
Through DeFi lending, NFTs can be used in liquidity pools.
Fractional ownership radically transforms what NFT selling can look like.
Non-fungible tokens are taking decentralized finance by storm. NFTs and DeFi are two of the largest applications in blockchain technology today. NFTs market capitalization was around $10.5 billion USD at the beginning of 2023, while the total value locked in DeFi was over $50 billion.
The use cases for both popular technologies are diversifying rapidly. They’re both transparent, secure, and decentralized means of exchanging digital assets on blockchain-based marketplaces. So, what are the differences between NFTs and DeFi? And how is the NFT DeFi world evolving?
NFTs and DeFi are two decentralized financial services intersecting to broadly improve function across the crypto-sphere. First, let’s see how they both work.
DeFi services allow users to buy, sell, and trade different cryptocurrencies or fungible tokens on decentralized exchanges (DEXs). DeFi platforms operate on blockchain networks, using smart contracts, oracles, and coins that can be traded. These dApps host an array of financial services similar to the traditional market, but unique in their decentralization.
NFTs, non-fungible tokens, are most often associated with digital art. NFTs are distinct assets that don’t hold the same value between them in the way cryptocurrencies do. For example, one ETH will always be equal to another single ETH. Instead, NFTs are unique, like pieces of artwork. Two artworks are intrinsically distinct, regardless of whether they sell for a similar price.
Many artists and musicians are becoming NFT creators because of royalty sharing. Once a piece of work is tokenized and sold, the artist can receive a royalty for each subsequent sale. NFTs aren’t limited to collectibles, though. Real-world assets can be tokenized, like houses in real estate investments, or cars for loan payments.
How are NFTs working in the DeFi space? To put it simply, an NFT is an individual means to store the value of an asset. NFTs are excellent because they store proof of ownership for users. Not only that, but the transaction and price history of the NFT are all transparent data. Decentralized finance is where that stored value can be unlocked and made liquid.
NFTs benefit DeFi in many ways. NFTs’ ability to verify ownership allows DeFi projects to trust the worth of the digital asset. And NFT markets benefit from DeFi involvement, improving interoperability and increasing liquidity.
Here are some of the ways NFTs are successfully plugging into DeFi, creating new opportunities and solutions.
NFTs are usually static assets — they don't generate passive income, though they might increase in value. Through DeFi lending, NFTs are being used in liquidity pools. An NFT’s value is assessed according to its current price, trends in the secondary market, and general demand for that asset. Similar to DeFi yield farming, liquidity providers add their NFT to a pool. Then the NFT owner receives interest without giving up their ownership.
There’s also the potential for DeFi projects to use NFT ownership as an entry ticket into exclusive-entry staking pools. If the staking pool’s returns are high, then the value of the NFT to access the pool will rise.
Many DeFi trading platforms operate as DAOs, or decentralized autonomous organizations. Most DAOs function through users buying governance tokens that enable them to either contribute to or vote on governance proposals. The details vary from organization to organization. Some operate so that each user has equal voting power. Others make voting power proportional to a member's coin amount.
Some DAOs find difficulty with this management style and would like something like a board of trustees in their organization. To do this, they introduce “soulbound tokens” which are NFTs giving permanent voting rights to specific users or wallets.
One of the biggest issues in DeFi applications is over-collateralization, where the collateralization amount must surpass the amount of the loan. NFT-backed loans allow for more diverse loan collateralization methods. The current floor price of the popular NFT “CryptoPunks,” for example, is 66.5 ETH, roughly $1,500 USD. They could stake their NFT as collateral for their loan, based on the floor price and the NFT’s purchase history.
One of the great pieces of this integrated DeFi NFTs system is debt management. If the borrower defaults on a loan, the dApp smart contracts automatically transfer NFT to the lender’s wallet.
Though there are many digital products emerging from NFT use in the DeFi space, one of the most exciting is insurance. Different policies can be converted into virtual tokens, then transferred, bought, or sold. Using NFTs, smart contracts, and DeFi platforms, hassle-free digital insurance policies are available. And, because smart contracts don’t expire, there’s no need for renewing policies unless there’s a needed change.
Whole NFTs can be highly illiquid. Some are massively expensive. The current floor price for Bored Ape Yacht Club surpasses $100,000 USD. It could take a long time for a buyer to come along to take something that pricey off your hands.
But fractional ownership radically transforms what NFT selling can look like. By splitting a single NFT into more purchasable pieces (often in the form of ERC-20 tokens) more buyers become available. NFT owners can also bundle their collection and fractionalize the whole thing, effectively making themselves an NFT index fund.
One of NFTs' great assets is their accessibility. They’re neatly packaged and easily distributable things, in theory. “Wrapping” an NFT means basically building something, like an insurance smart contract, and “wrapping” it into an NFT format. As an NFT, it is more easily bought, sold, or traded than it would be as a smart contract. There’s also potential to wrap fungible tokens into an NFT format, creating a sort of savings account for liquid assets.
There are many NFT marketplaces integrating the DeFi sector. Here are a few of the biggest names in the NFT-DeFi space today:
Rarible is an NFT marketplace that’s been at the forefront of intersecting NFT and DeFi. Rarible has built an NFT exchange protocol fit with an NFT Index for new collectors. Their exchange protocol is operated through a DAO and community treasury.
Usually, locked assets are illiquid, but not in Solr. Solr Protocol wraps illiquid assets into NFTs that users are then able to buy, sell, or trade.
Charged Particles make NFTs out of any token deposited. Like an NFT-savings account, users can store and hold assets and coins of their choice in a minted “particle.”
NFTfi is a peer-to-peer lending and liquidity protocol on the Ethereum network. Its platform is run as a DAO, and each NFT’s value is estimated by the members of the DAO. NFT holders are welcome to stake their tokens as collateral for a loan. And lenders in NFTfi can often gain either good yields or valuable NFTs from defaulted loans.
WiVX is a fun example of tokenizing real-life assets, because each WiVX represents a physical case of wine. Owners of WiVX can trade, collect, or use their tokens as collateral. Or, if they’d like, they can say the word and receive their wine case on their doorstep. But to drink up, they first have to burn the token to take it out of circulation.
The merging of NFT in DeFi has the potential to make a new and better digital financial system. But there are a few areas for progress to be made.
The curve model was designed to distribute liquidity across the whole curve within DeFi protocols. Using this model has led to backups of liquidity without actually generating returns for the liquidity providers.
Desired custom price sizes are now being selected by providers, allowing them to gauge their capital within the curve model. Though this is still an imperfect science, the NFT DeFi combination allowed for these price sizes to come into play.
Traditional finance is still having a hard time fitting decentralized finance into its idea of wealth. From a regulatory standpoint, there are still issues with whether to consider NFTs as secure financial assets or not. This question will no doubt evolve as decentralized finance grows and traditional finance acclimates to DeFi’s popularization.
Though NFTs are easily tradable, there is still a long way to go before their use becomes widespread. Information, complex coding, and fear of scams are big barriers to entry for lay people. The good news is, these technologies are exciting and efficient. NFTs and smart contracts have potential in various industries, like real estate. They’re for much more than just the crypto-elite.
The NFT DeFi combination is an exciting decentralized development. And at Hedera, we’re constantly progressing.
Hedera’s NFT marketplace offers a sleek browser wallet to manage NFTs and low fees to mint, transfer, and bridge. All NFTs are configured and minted using interoperable standards. And, for ease of use, NFTs are bridged over to Ethereum. To cap it off, the entire NFT creation and exchange process is carbon negative, using our carbon credit marketplace.
Hedera offers an accessible, affordable, and green interface of NFTs and DeFi.