It's safe to say that before NFTs became popular, not many people were familiar with the term “fungible assets” and its meaning in economics. Fungible tokens like ETH and BTC can be traded for any other identical token and share the same value, much like fiat currency. NFTs (non-fungible tokens) are unique and helpful in storing value because each can be unique and thus are not interchangeable with any other similar token. An NFT in a collection with unique properties can be valued more highly than others in the same collection.
The drawback to the uniqueness of NFTs is that they are static assets and are only worth what others are willing to pay for them. They also cannot be used to generate yield as BTC and ETH can. For example, if you have a Cryptopunk and the floor of the collection is valued at 70 ETH, this is an illiquid asset in your portfolio. If you want to use it to generate yield, you will have to sell it first by finding a buyer willing to give you what you think is a fair price. This process takes time, and by selling the NFT, you risk missing out on further gains if its value later goes up.
The NFT market thus has several main challenges. They are static by nature which precludes holders of very valuable NFTs from earning yield on their investment after they buy. Also, NFTs are illiquid, and it can sometimes be challenging to sell them without heavily discounting the price. This article will dive into a few protocols that seek to solve these problems.
NFTX and NFT20 are two protocols that tokenize NFTs and have decentralized exchanges where the tokens can be traded. They have similar mechanics, and we will focus on NFTX in this article since it is currently more popular.
NFTX's main value proposition is to create liquidity in the NFT market. It uses a vault system whereby NFT holders can deposit their NFTs to mint a token which can be traded at a 1:1 ratio for any other NFT in that vault. The user can then take these "vTokens" and sell them on a DEX, thus enabling price discovery. In theory, the price should be right around the floor price, and this market action will help solidify the actual floor price of the collection.
Vault creators can set fees on NFTX, which are given out to vault token liquidity providers. Once the tokens have spread into the broader market, they can be traded just like any other token. A high-value NFT holder can now be guaranteed that they will get the floor price for depositing their NFT into the vault, thus making their NFT both liquid (quickly and efficiently traded) and fungible (exchangeable for other assets like ETH).
These vaults are floor vaults, meaning that every NFT deposited in them essentially has the same value because they can all be redeemed for one token from the vault. So it’s not beneficial to deposit high-value NFTs from a collection into the vaults, but it would be helpful for pieces that a user wants to sell at or near floor price.
One of the main issues with NFTX tokens is that they do not yet have deep liquidity pools, which would make trading them more reliable and efficient. FloorDAO is a protocol that seeks to solve this issue by accumulating large amounts of the tokens and making liquidity pairs with its native FLOOR token. It uses the OHM rebase model, with an APY of around 2,500%, and a bonding system to incentivize users to stake their NFTX vault tokens.
FloorDAO will offer bonds first with PUNK tokens. This bond will give users FLOOR at a discount which they can then stake to receive rebase rewards (giving the protocol access to the PUNK tokens to be used as liquidity).
FLOOR tokens can also be wrapped into a governance token for the protocol. Governance will be vital because it will determine which assets are accepted by the FloorDAO treasury. If you want to get your NFT collection listed, you will have to accrue enough votes in the protocol to do so. At the time of this writing, the NFT collections accepted on FloorDAO are PUNK, WIZARD, and MAYC.
JPEG’d is a new protocol that will give users the ability to take out loans against the value of their NFTs. This will allow them to generate yield with their NFT without giving up ownership. Revenue will be generated for the protocol through interest on the loans. It boasts some of the most prominent figures in CT on its advisory teams such as Tetranode and TzTok-Chad
JPEG’d uses a custom decentralized Oracle solution they developed with Chainlink, which fetches a time-weighted average price (TWAP) on NFT collections such as Punks. The TWAP method is essential because floor prices can change rapidly if the most recent sale price is used and thus can be manipulated by bad actors. Using a TWAP makes manipulation much more challenging and more expensive.
This price is then used to mint their in-house stable coin PUSd, which can then be traded for other stables or used to generate yield. The JPEG token is valueless and utilized solely for governance. Although it is imperative to the function of the protocol as users can use locked JPEG tokens to increase the amount of collateral they can take out on their NFT (the base rate is set at 32%, and the NFT will suffer liquidation if debt/equity ratio is 33% or higher).
They also offer liquidation insurance for NFTs deposited on the protocol. For 1% of the NFT value, users can buy the right to repurchase their NFT in the event of liquidation by paying a 25% penalty on its valuation. In the case of a liquidation, the DAO can choose to hold the NFT or sell it OTC (over the counter).
All of these protocols are very important to the function of NFTs as productive assets, and indeed as the NFT space continues to grow, more innovations like these will be necessary. It's yet to be seen whether NFTs will go through their own DeFi summer in 2022!
*Nothing in this article is to be deemed financial advice