DeFi and NFTs are the most notable trends in the existing crypto market. They are currently the two most popular applications of blockchain technology. NFTs focus on the tokenization of assets, while DeFi provides direct access to financial services without disclosing the user’s identity.
Non-fungible tokens are often thought of as just digital art or collectibles that rise in price thanks to hype. But NFTs are more than that. They are also a suitable instrument for DeFi, so enterprises may take advantage of the combination of DeFi and NFT.
In this article, we will take a closer look at DeFi and NFT to find more ways to get the most out of the combination of these technologies.
DeFi stands for Decentralized Finance. It is an umbrella term that refers to peer-to-peer financial services provided on public blockchains, most notably Ethereum. Through DeFi, you can borrow and lend money, earn interest, buy insurance, and trade derivatives and assets.
Like the crypto industry in general, DeFi is much faster than traditional financial services and does not require the involvement of third parties. DeFi is global, accessible to everyone, anonymous, and peer-to-peer, meaning that all services take place directly between two users.
In other words, DeFi is the digital version of banks and other financial services that utilize blockchain technology. Likewise, DeFi provides an alternative banking system in exchange for a small service fee.
DeFi services are enabled by decentralized applications, most of which run on the Ethereum platform. DeFi also uses cryptocurrencies, oracles, and smart contracts to facilitate decentralized financial management.
Decentralized finance draws a lot of attention from investors and leaders in the blockchain space, who are ready to take advantage of this technology.
Decentralized finance has significant advantages that make it one of the most popular use cases of blockchain. Let’s see what they are.
NFT stands for a non-fungible token, which is a unique crypto token that exists on a blockchain and cannot be copied. NFTs are digital assets that represent artwork, music, in-game assets, and real estate. Briefly, NFTs provide documentation that proves the digital asset they represent is the original. Non-fungible tokens serve as digital certificates of ownership for real-world objects.
Let’s dig a little deeper and define tokens. Tokens are digital assets that store value on a blockchain, a globally distributed digital ledger. Network members can read or add records to the ledger, but anyone can corrupt or manipulate it. For example, you can hold a token that represents 5 ETH, 50 shares of a company, and so on.
Most tokens on a blockchain are fungible assets, meaning they are completely interchangeable and indistinguishable from each other. Therefore, any token representing 1 ETH is the same.
Non-fungible tokens allow users to create unique data on a blockchain. These tokens hold their own codes and are, therefore, scarce. To sum up, a non-fungible token is unique and one-of-a-kind, meaning it doesn’t have a recognized market price and cannot be exchanged for an asset of equal value.
Let’s explore the benefits of NFTs that make them so special.
In the world of DeFi, design patterns are beginning to intersect with NFTs and NFT marketplaces. Rarible is one of the decentralized finance projects that provides a creator-centric NFT marketplace. It provides a governance token called RARI and implements all the necessary mechanisms for regulation under a Decentralized Autonomous Organization (DAO).
RARI token holders, including creators and collectors, would be able to vote on platform improvements and actively participate in moderating the marketplace itself. RARI also includes an NFT index that serves as a portfolio for NFTs to help all collectors view works of art and select the most appropriate for investment.
There is no doubt that non-fungible tokens can revolutionize a lot of traditional operations. Let’s see how they can benefit the world of decentralized finance.
Traditional centralized financial systems have always been managed by governing bodies that control investments, trade contracts, and transactions. The authorities ensure that all transactions and activities are accountable and reliable. However, there are several drawbacks to this approach. First, the review and approval process can be time-consuming, which results in physical delays and significant costs. What’s more, the risk of error, fraud, and interaction with malicious actors is higher when too many people are involved.
Fortunately, decentralized finance has all the tools needed to provide a solution to these problems. It offers an efficient and transparent way to manage finances without putting privacy and security at risk. Sounds pretty promising, doesn’t it? But NFTs bring even more benefits.
At present, many DeFi projects are implementing NFTs because of their ability to store value and act as immutable proof of ownership. In its turn, DeFi helps to unlock the value stored by NFTs and perform all kinds of operations with tokenized assets. To sum up, these two technologies are mutually beneficial and offer new opportunities in the financial industry.
Resolving the problem of collateralization
One of the most important aspects of the combination of NFT and DeFi is the ability to unlock value. However, it is still difficult to select particular mechanisms for determining the value of NFTs. At the same time, the use of NFTs can help the lender specify the amount of collateral in DeFi.
First, the borrower must request a loan amount secured by an NFT. Then, the lender estimates the loan amount and the collateralized NFT. They must consider several factors, including a secondary market value, the holder’s price, and their individual calculations.
The easiest way to solve the collateralization problem is to use NFTs and DeFi simultaneously. It is also important to mention the issues related to market liquidity. Take the art and collectibles area, for example. It is quite subjective in terms of liquidity.
Imagine that a painting is worth nearly $1 million. However, the price of the artwork only has value if a potential customer is willing to pay for it. To easily solve the problem of securing artwork, you can use NFT DeFi. In this case, the most reasonable solutions may focus on using NFT art and digital collectibles as collateral in DeFi lending.
In the real world, traditional art has conventionally been used as collateral. Hence, the use of NFTs in the DeFi industry seems to be a reasonable step toward the future. In addition, NFTs are likely to improve the DeFi domain by solving liquidity issues via tokenization. In turn, tokenization could provide a more flexible way to prepare an illiquid asset.
Addressing the concerns of the curve model
The curve model was originally designed to distribute liquidity across the entire curve. This model emerged with one of the versions of DeFi protocols related to liquidity pools. At the same time, the curve model includes the significant growth of liquidity without any returns for the providers.
Fortunately, the combination of NFTs and DeFi has successfully provided a solution that allows liquidity providers to select the desired custom price sizes. This allows liquidity providers to easily estimate their capital and tackle the issue of liquidity in the curve model. As a result, liquidity providers could also gain greater exposure to desired assets while reducing downside risks.
NFT ownership and its impact on DeFi
The examples of using DeFi platforms together with NFTs for the music industry indicate a revolution in the art world. Additionally, non-fungible tokens play an important role in enabling ownership and profits for the actual creators. NFT holders can get a reliable share of the revenue from streaming or reselling their works.
Another effective collateral option is to maintain verifiable income through NFTs. It can also provide easier access to undercollateralized loans, which is impossible without the use of NFTs in DeFi. In general, the monetization of art and collectibles via NFTs has become an essential part of the overall narrative of NFT hype. However, NFTs may become more advanced tools for addressing the issues of licensing, royalty sharing, and copyright ownership.
The concept of fractional ownership is another use case of NFT DeFi. Thus, you can create shares of the NFT to allow investors to own the NFT without purchasing the entire token.
In the traditional system, the bank sets the amount of collateral. With decentralized finance, lenders are allowed to make such decisions.
NFTs streamline the process of securing collateralized loans by allowing the borrower to provide a token to eliminate the lender’s risk if the loan can’t be repaid. The lender can assess the current price of the token and examine secondary market trends and demand for that specific kind of asset to make an informed decision.
There are several platforms where NFT holders can submit loan requests. Arcade, Genesis, NFTfi, and TrustNFT are some of them.
Take the Arcade platform, for example. It is built on Ethereum and enables peer-to-peer lending and borrowing. Arcade uses the Pawn protocol, which combines DeFi and NFTs, so any ERC-20 token can be used as collateral.
When applying for a loan, the borrower must indicate the desired amount of money, the currency, the disbursement amount, and the loan term. The interest rate depends on the kind of NFT, the loan-to-value ratio, and the loan term. The average interest rate is around 20%.
Some NFTs are too expensive for the majority of people to afford, so it may take a long time to find a potential buyer. However, when the token is fractionalized, the price is divided among multiple buyers, making the token much more liquid.
NFTs and DeFi transform traditional insurance products and crypto-related assets in the insurance industry. Insurance policies are converted into NFTs and can be bought, sold, or transferred.
There’s no need to periodically renew documents, collect all the necessary paperwork, and meet with bank officials for verification because NFTs have no expiration date.
CoverCompared is an example of a project that combines DeFi and NFTs to effectively manage insurance. The solution aims to reduce the price of insurance policies, as well as administrative and transaction costs.
All CoverCompared products can be purchased with cryptocurrencies on a native marketplace. The platform plans to enable multinational insurance providers to access all global insurance products, including crypto-related protection, health, life, and travel policies.
Debt management is another area that can gain considerable benefits from implementing NFT DeFi. The larger the company, the more employees it needs to track its financial issues, including debt.
Smart contracts help eliminate human error and dramatically reduce the time spent on repetitive tasks such as approvals and calculations. Plus, you can check the details at any time because all the data stays on the decentralized ledger.
Imagine someone owes you a debt secured by an NFT. If they can’t pay you back, you automatically get the NFT without going to court.
NFT staking benefits
NFTs can provide benefits and utility to their holders. For example, some DeFi projects offer access to certain staking pools only to holders of a particular NFT. Therefore, the value of the NFT is based on the attractiveness of the staking pool returns.
DeFi governance is usually realized through token holders who have voting rights according to the amount of tokens they hold. Still, some DeFi projects have faced limitations with this model, so they are looking for other solutions. For example, they are trying to add permanent members or councils to the process.
To facilitate this, DeFi projects allow the use of NFTs that give their holders voting rights. These NFTs are known as soulbound tokens, meaning they can’t be transferred and are always kept in a particular wallet.
With such a wide range of potential applications, many projects in the industry are taking the opportunity to take advantage of the NFT and DeFi combination. Let’s take a closer look at some of these solutions.
Uniswap is a DeFi protocol for automated liquidity provision and cryptocurrency exchange. Uniswap3 addressed the issue of temporary loss common in the Curve protocol and created a whole new application for NFTs by introducing non-fungible liquidity pools.
As a result, liquidity providers don’t have to participate in all prices in the pool but can distribute their capital over a specific price range. In other words, liquidity providers achieve higher exposure to desired assets while reducing the downside risks.
Solv Protocol is a DeFi platform that enables the creation and trading of Solv Vouchers, which are specific NFTs. Solv Vouchers are a type of derivative that represent vesting assets, namely tokens. These assets are locked up and then released periodically. This guarantees a long-term commitment from team members and investors, strengthening the project’s growth and success.
Locked assets are typically illiquid, so the only thing to do is to passively wait for the vesting period to expire and claim the assets. Solv Vouchers allow the owners of the locked assets to actively control them, meaning they can buy, sell, split, and merge vouchers into larger entities.
Solv Protocol issues financial NFTs with the ERC-325 token standard to streamline the implementation and programming of advanced financial products.
Charged Particles is a protocol that allows any token to be stored in NFTs. Thus, ERC-20, ERC-271, and other tokens become a sort of virtual basket containing diverse digital assets.
For example, if you deposit Aave tokens and then convert them to NFTs using the protocol, you will receive earning assets. In this way, you generate interest that is programmable, which means that you have full control over it and can send it to any wallet.
In addition, such tokens can be used to create NFT-based savings accounts, virtual geocaching, charity art sales, and entertainment NFTs.
NFTfi is a liquidity protocol for NFTs. It allows users to lend and borrow non-fungible tokens in a peer-to-peer and reliable manner. NFT liquidity providers use the protocol to generate potentially lucrative yields or to gain valuable NFTs in the event of loan defaults.
NFTfi is available on the Ethereum blockchain, but it is expected to become available on Flow as well.
Burnt Finance is a decentralized NFT auction protocol that operates on the Solana blockchain. The platform allows users to create unique NFT collections and host digital asset auctions and fundraising campaigns. It has low transaction costs ($0.01) and high speed (400 milliseconds to process).
Burnt Finance is planning to expand and build an NFT marketplace with full DeFi functionality such as fractionalization, GameFi, lending, and liquidity mining with staking incentives.
WiVX, introduced by WiV Technology as an extension to its blockchain-powered wine investment platform, is a decentralized reserve token protocol.
Each WiV token is a digital representation of a case of wine. Therefore, holding a token means that you own real-world wine. All cases of wine are securely stored within the WiVX merchant network or in a professional warehouse in the owner’s custody. In addition, the wine will be delivered to the owner upon request.
The tokens can be used for creating a collection, trading, or as collateral for a loan.
Pods is a decentralized non-custodial options protocol that offers an easy way to hedge cryptocurrencies in the sphere of NFT DeFi. In 2021, the project joined the Galaxy ecosystem and launched its own NFT reward program. According to the rules of this program, rewards are distributed to the first adopters and the most enthusiastic participants of the community.
The first season of the rewards program was the Awakening, which was made up of three NFT groups. In the future, Pods NFT holders will be able to access early testing and research groups, hold certain community positions, and vote on governance initiatives.
Just Liquidity is a financial system that strives to build a fully decentralized experience with global fiat applications such as Mastercard Debit Card and Visa. Currently, the system offers an NFT staking model.
Users can stake their digital assets in a pool for a certain period and receive an NFT to gain access to the next pool. Thus, the NFT acts as an entry ticket to a new pool and expires when the user finally joins the pool.
The project’s NFT staking model creates a secondary market for these NFTs based on the access provided.
NFTs are making a difference in the DeFi industry by getting to the heart of its operations. One of the most significant benefits non-fungible tokens bring to the DeFi space is the verifiability of ownership. The simplicity of proving NFT ownership opens up DeFi solutions for NFT holders to obtain loans using NFTs as collateral.
NFT-backed loans are gradually gaining popularity, so the growth of NFT DeFi as such is likely to bring more innovation to the industry. It is crucial to understand that NFTs can assign value to almost anything. In turn, DeFi unlocks the value of a particular asset. As the number of users grows, NFTs and DeFi could change the way we view assets, financial services, and tokens.
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