For NFT fans, the past 24 months have been a whirlwind, with enormous demand for digital ownership spawning a brand-new and thrilling asset class before our eyes. But all shiny new things eventually lose their appeal. After a time of buying, selling, and trading NFTs, investors are also looking for new ways to make their investments grow. You read correctly. People are lending their comparatively unliquid JPEGs in exchange for immediate rewards in cryptocurrency and cash. And it has grown to be a sizable market segment. It’s finally time to talk about the basics of NFT lending, like how it works and what kinds of loans there are. First, though, is a definition.

Describe NFT lending.

NFT lending is a way to get a loan by putting up your NFT as collateral. In exchange, you get paid in cryptocurrency right away. And it resolves liquidity, the biggest issue facing the asset class. NFTs aren’t as liquid as other types of assets, which makes it hard to sell your NFT quickly for its market value in cash (or cryptocurrency). In other words, it can take several months before a JPEG is purchased. Also, investors may find it hard to get their hands on cash quickly if they have a lot of their money invested in non-traded funds (NFTs). In addition, loans give NFT owners a way to create money that is not subject to taxes, as opposed to the tax consequences of a sale. This is how the borrower requests a loan and pledges a valuable object as security (NFT). In return for interest, the lender grants the loan. But if the borrower can’t pay back the loan according to the terms, the lender will take the collateral. Most of the time, this operation is done by smart contracts on the blockchain. NFT lending, on the other hand, is always done using one of four main models, each of which has pros and cons.

Peer-to-Peer: Streamlined NFT Lending Platforms

Peer-to-peer lending is the most basic type of NFT lending since it closely mirrors the interaction between a borrower and a lender you may find at your neighborhood bank. Most transactions happen on P2P NFT lending platforms like NFTfi, and the way they work is usually the same. NFTs are a little trickier than borrowing against a stable-priced asset, though. Due to how volatile the market is, the value of an NFT on the market now can be very different from what it will be in the future. How, then, do you determine its current worth? In actuality, it depends. The majority of peer-to-peer lending platforms let individuals create loans and set terms without the need for a centralized or outside mediator.

A value user who lists their NFT on the site will get loan offers based on the lender’s estimation of the NFT’s value as collateral. The borrower will receive a wrapper of ETH or DAI from the lender’s wallet as soon as they accept the offer. Until the loan is paid off or expires, the platform will automatically move the borrower’s NFT into a virtual escrow vault (a.k.a. smart contract). If the borrower doesn’t repay the loan, the smart contract will send the NFT immediately to the lender’s wallet.

Combining various NFTs with Arcade, among other things

Using other platforms like Arcade, users can combine or “wrap” several NFTs into a single collateralized asset. Unlike NFTfi, Arcade lets borrowers choose their preferred terms and payback periods ahead of time before searching the market for a suitable lender match. The process starts after a game is found. The final word? Peer-to-peer lending has become the best choice for both borrowers and lenders because it is easy and safe. The unique qualities of NFTs are taken into account by the fact that both parties can set their terms, and the logic of the smart contract used in the escrow process is pretty simple. However, peer-to-peer lending may not be the quickest option, as it depends on a borrower finding a lender willing to agree to terms they can both live with.

Peer-to-peer lending is not only the safest model but also the most liquid and competitive on the lending side, says Richard Chen, General Partner of cryptocurrency-focused investment firm 1confirmation. Since NFT lending currently offers the best yields in crypto, DEFI lenders have turned to it as DEFI yields have declined. Since NFT lending offers the best crypto products, DeFi lenders have turned to it as DeFi yields have fallen. According to Chen, who spoke with NFT now, “if you list a cryptopunk on NFTfi, you’ll get a dozen offers relatively quickly.”

Also Read: Top 4 Questions That Are Frequently Asked About NFT Staking

NFT peer-to-peer lending

As the name suggests, peer-to-pool lending lets people borrow money right away from a liquidity pool without looking for the right lender match. Peer-to-pool systems like BendDAO use blockchain bridges (specifically Chainlink oracles) to get floor price data from OpenSea and give value to collateralized NFTs. Users may quickly access a predetermined percentage of their NFTs’ floor price as an NFT-backed loan. The protocol is then locked concurrently with the NFT. The timing of repayment has no bearing on when liquidation occurs. Instead, it happens when the loan’s health factor—a measure of safety expressed in numbers and made up of the outstanding loan balance and the market value of the collateral—drops below a certain level. But the borrower has 48 hours to pay back the money and get their money back.

While platforms like Pine provide access to more NFT collections, BendDAO only works with a few high-end NFTs. Rare NFT owners are at a disadvantage because these platforms price assets based on a floor price, which limits how much cash they can get. Additionally, the borrowing market is substantially smaller. Lenders who put money into the liquidity pool get bendETH tokens with interest worth the same as the money they put in. But most importantly, Chen says that the platform and hacking risks are much higher than with peer-to-peer. In other words, you gain speed but lose flexibility with peer-to-peer lending.

Chen said that because NFTs are less liquid than other tokens, price oracles used in peer-to-peer systems are much more likely to be wrong. Although there are practical NFT appraisal tools like Deep NFT Value, according to him, “teams are running their centralized oracles, which are susceptible to infrastructure hacking risk” because there is “no oracle infrastructure yet.”

Debt holdings that are non-fungible

MakerDAO’s collateralized debt position structure led to non-fungible debt positions, in which borrowers over-collateralize ETH (a risky asset) in exchange for DAI (a less risky stablecoin). But on NFDP platforms like JPEG’d, borrowers, put down specific blue-chip NFTs and get $PUSd, a fake stablecoin tied to USD, instead of putting down ETH and getting a DAI. Like peer-to-peer lending, JPEG uses unique chainlink oracles to get and update information about prices on the chain. The goal is to accurately add floor prices and information about sales to collateral prices in real-time.

Non-fungible debt positions are still young and need more time to grow before they can be trusted as a way to lend money. To make ETH less volatile, MakerDAO’s collateralized debt holdings are overcollateralized by 150%, the same as 1.5 times. Even more volatile than traditional financial instruments, NFTs make it hard to predict the market and raise questions about possible liquidations because they don’t need as much collateral. Additionally. The market is small, and the platform risk is rather significant because JPEG is now the only platform that offers this structure and is exclusively available to CryptoPunks. Non-fungible debt positions should, in general, be closely scrutinized as the situation develops.

Now tracking @llamalend on @ethereum

Deposit NFTs and borrow ETH for small illiquid NFT collections that can’t get into the main NFT lending marketshttps://t.co/hKxF40ohc9 pic.twitter.com/gKQkbGYrFn

— DefiLlama.com (@DefiLlama) November 5, 2022

NFT rentals and leasing via capital

NFT renting goes against the norm and lets people who own NFTs rent them out in exchange for cash upfront. Similar to peer-to-peer markets, platforms like ReNFT allow renters and tenants to interact with different rental conditions and agreements immediately. Smart contracts make all rental transactions possible, just like trades on NFTfi. But the NFT is sent to someone else’s wallet for a set amount of time instead of the borrower giving up the NFT as collateral and locking it in a digital vault. The “borrower” gets a lump sum of cryptocurrency in return. The NFT is automatically returned to its owner after the designated time frame. Since there are no repayment conditions, interest rates, or concerns about liquidation, this is the most basic form of “lending.”

Owning a costly NFT can boost attention and recognition in the NFT space, which depends heavily on social proof. Most of the time, NFT rentals give lenders access and credibility. This differs from other lending types, where lenders get paid by earning interest. In some token-gated communities, renting an NFT lets users talk to others and do things they wouldn’t be able to do otherwise. The NFT rental market, which is growing, is expected to last the longest since it is similar to renting clothes, cars, and other status-related goods. Whether or not you should invest in NFT lending depends on how much time you have and how much risk you are willing to take. As with any crypto protocol, it’s essential to research and not use too much leverage or invest money you can’t afford to lose.