Despite the protracted crypto bear market, innovators in
non-fungible tokens (“NFTs”) are hard at work. Gone are
the days when NFTs were merely profile pictures (“PFPs”)
displayed on a pseudonymous social media account or shown for their
prestige online or in real life to confused friends and colleagues.
As discussed in our two-part series explaining Ordinals and their implications for NFT owners and creators, this
year NFTs have expanded beyond the Ethereum blockchain, where NFTs
initially grew to prominence as a result of the blockchain’s
ability to execute smart contracts, to the original blockchain,
Bitcoin.
Beyond Ordinals, gaming-related innovations, new ERC standards, and other innovations, the
industry continues to push forward to new frontiers, such as
NFT-based lending.
This is Part I of a two-part article on NFT-based lending (Click
here for Part II). In this part, we will
discuss recent innovations in NFT-based lending, explaining various
mechanics and functions. In Part II, we will dive into the legal issues
for lenders involving secured transactions under the UCC, Pre- and
Post- Article 9 and 12 Amendments.
Recent Developments in NFT Lending
Like traditional secured financing, where a loan is extended
based on obtaining a security interest in the assets or cash flow
of the borrower, NFT lending allows owners to log onto a NFT
lending platform to borrow money peer-to-peer from willing lenders
(or peer-to-protocol directly from a protocol liquidity pool) using
the NFT as collateral. Such financing arrangements provide
liquidity to creators and owners and will unlock monetization
opportunities, all using smart contracts that clarify counterparty
risk and default-related remedies.
Earlier this year, Blur, an NFT marketplace and aggregator,
launched Blend, its so-dubbed “peer-to-peer perpetual lending
protocol.”1 Blend protocol provides two different
lending services: (1) purchase an NFT using a “buy now, pay
later” service; or (2) leverage an already-owned NFT to
provide liquidity to the owner. Technologists quickly determined
Blend’s protocol was a significant advance: whereas most prior
iterations like peer-to-pool protocols use pools to provide
leverage directly to borrowers at a set loan-to-value ratio,
determined by oracles, which is a process less suitable to
volatility due to the potential for automatic liquidations if the
NFT valuation dips below a certain reserve or the borrower defaults
before the end of the loan term (if an expiration exists), newer
peer-to-peer services like Blur and others allow for individual
borrower-lender negotiations, lending themselves (no pun intended)
to greater flexibility as a result. Peer-to-peer protocols are more
flexible, in part, because they avoid dependencies on oracles,
which are third-party information feeds typically provided by
centralized services that supply NFT prices, interest rates and
other information. Oracles increase the risk that inherently
volatile collateral will prematurely liquidate and are subject to
manipulation by certain trading strategies; thus, many consider
Blend’s peer-to-peer lending protocol a much-needed
breakthrough.
So, how do borrowers and lenders utilize a peer-to-peer protocol
such as Blend?2
1. Lenders
Lenders begin with the same process as borrowers: connect a
wallet containing necessary funds. If a Lender is willing to fund
against a certain NFT, it states the maximum amount it is inclined
to lend against any NFT in a collection, not the specific
NFT itself. Some NFTs in an NFT collection are rarer than others,
resulting in varying asset prices within the collection. Lenders
set their fixed interest rate for a specified collection and wait
for borrowers to accept.
Lenders may claim accrued interest by closing their perpetual
loan at any time, which begins the automatic Dutch auction process;
at this point, a new lender may purchase the loan. The loan’s
sale process initiates at a 0% interest rate and can climb to a
maximum of 1,000% APR. If there’s a buyer, the borrower has the
option of accepting the new terms or not. If there’s no new
buyer after 6 hours, the borrower has 24 hours to repay the
loan—failure to repay results in the liquidation of the NFT
– the collateral.
2. Borrowers
First, a borrower who has connected their wallet with necessary
funds selects the NFT collection and list of items to purchase or
an NFT from their inventory to leverage. Borrowers then review
their loan offers, which the protocol aggregates based on price and
interest rate. Borrowers then select the price and interest rate
they want to pay for a specified NFT or request a loan amount and
interest rate for an already-owned NFT.
The loan is perpetual – hence, there’s no expiry.
Borrowers can pay it off at any time by either (1) selling the
borrowed NFT and repaying the principal plus interest or (2)
entirely repaying the loan and keeping the NFT. Borrowers should
note that lenders can request payment whenever they choose (i.e.,
due to price volatility or if the NFT value drops precipitously),
at which point a Dutch auction begins.
As illustrated NFT-based lending represents an innovation in the
blockchain industry and NFT technology that may usher in a new wave
of value and investment. In Part II, we will explore the legal issues
implicated by NFT-based lending. Stay tuned!
Part I: NFT Lending — Legal Issues Involving
Secured Transactions under the UCC, Pre- and Post-Article 9 and 12
Amendments
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
This news is republished from another source.
