Art and collectibles (A&C) are the subject of such hype in the NFT field that one might think that NFTs boil down to these areas only. Certainly, the vast majority – but not all – of NFT projects to date have focused on art and collectibles. The quarterly studies published by NonFungible paint an interesting picture: in terms of volume, A&Cs represented 91% of the market in the first quarter of 2021, then 85% in the third quarter. This simultaneously shows the dominance of A&Cs, while highlighting the growing presence of other NFT projects.
As NFT use cases grow and diversify, the market grows (surpassing $40 billion in 2021, according to Chainalysis), and the benefits of the technology are increasingly recognized, two questions remain: what is preventing the mass adoption of NFTs and how to achieve it?
In a recent article on this topic for Cryptonews.com, Kiril Nikolov suggests that the brake is partly the low level of adoption of cryptocurrencies in the world (it is estimated that only 106 million people hold cryptos), but especially the lack of utility and services that can make NFTs accessible and useful in people’s daily lives. One of the key services mentioned by Nikolov is the development of financial tools.
Read also: Two new standards dedicated to NFTs and tokenized assets for Ethereum (ETH)
Motivated by the importance of developing this new frontier, this article proposes that such financial tools can be defined and grouped under the term “NFT Finance”. In the following sections, I will explain what NFT finance entails, propose a framework for understanding existing and future financial products, and show how it can improve an incredibly diverse range of global industries. Most importantly, I argue that NFT Finance is key to the widespread adoption of NFTs and the expansion of liquidity and growth of NFT markets, within and beyond art and collectibles.
What is NFT Finance and why is it important?
First, let’s take a look at what NFT Finance entails. In the first paper published in the collaborative research series between CadLabs and NFTfi, entitled “The Advent of NFT Finance”, NFT Finance was defined as,
“Web3 infrastructure and all markets for NFT-based financial products and services”.
To understand what this means in practice, it is useful to make comparisons with the traditional finance (TradFi), art and collectibles and real estate sectors.
In TradFi, services that take place outside the main banking system, or that serve niche assets, are called Specialty Finance. In the world of A&C, the financial services that have developed in recent decades, from artistic investment vehicles to loan providers and securitization platforms, are therefore considered a form of specialized finance. The existence of these financial products makes it possible to increase activity in the art and culture market, as actors free up capital, carry out more complex transactions and participate in new ways in the purchase or sale of works of art, especially on the secondary market. Similarly, the financialization of real estate in the 1990s, with the creation of mortgage products and derivatives and the securitization of loans, was crucial for the development of this sector.
These comparisons help us envision what the financialization of NFTs can offer NFTs, creating liquidity and new markets based on these tokens that would significantly expand the opportunities and scope of investment, value creation, trade and other forms of market participation.
NFTs have the potential to be widely adopted
NFTs can be anything. Any economic activity built around separate units could therefore benefit from the existence of these units on a blockchain as an NFT. These benefits, to name a few, include greater transparency, accountability, traceability, efficiency, reliability and composability. Which industries in particular could benefit? For starters, all those who have non-fungible items at the heart of their business. Here are a few examples:
Supply chain management: NFTs can authenticate products and ensure quality standards. Thanks to the traceability of NFTs, the origin of products can be verified and their movements can be tracked at every stage of transport and production. This is a major advantage for any business dependent on supply chains, from food to fashion to pharmaceuticals. The potential impact of better supply chain management around the world cannot be underestimated.
Patents and Intellectual Property: NFTs can be used to transfer ownership. Patent owners’ records can be kept on the blockchain and tokens containing self-executing contracts can transfer the legal rights associated with patents when transferring the tokens. A notable development in this space is a partnership between IBM and IPwe to create the infrastructure for a global patent marketplace where tokenized patents can be exchanged via NFTs. The usefulness of this platform will go beyond simple sales transactions, also allowing participants to license, finance, search and market patents. This is a key indicator of how the integration of NFTs into an existing sector can be improved by creating additional financial products and systems (NFT Finance) that provide flexibility, liquidity and efficiency. Expanding on precisely this topic, said Erich Spangenberg, CEO of IPwe.
“The use of NFTs to represent patents will help create entirely new ways of interacting with intellectual property. This should benefit not only large companies that own significant intellectual property, but also small and medium-sized enterprises and even individual IP holders. We believe it will pave the way for new offerings from financial services companies and businesses to promote the evolution of a new patent asset class.”
Real estate: NFTs are not only fundamental for virtual real estate in the metaverse, but are already being used to facilitate physical transactions. In February 2022, the first NFT-related home sale took place in the U.S. through Propy, a startup that combines real estate with NFT lending. In this case, the NFT was not linked to the deed of ownership of the dwelling but to the ownership of the Limited Liability Company that owns the physical asset. This is just the beginning of experimentation in this sector, as the many potential applications of NFTs are now recognised and the development of DeFi mortgages is underway, this will undoubtedly encourage further NFT-based transactions in this space.
The above examples clearly show how NFT Finance’s products are growing organically as the use of NFTs accelerates in non-art and collectibles sectors, and the enormous potential of NFT Finance to facilitate their integration. However, they also stress the need to continue research and development of NFT Finance’s opportunities in general terms, rather than on a sectoral basis.
To do this, we need a framework to categorize the main types of NFT Finance infrastructure that can be applied to all sectors.
A framework for NFT Finance
In the recently published series of articles “The Advent of NFT Finance”, Giulio Trichilo and Jonathan Gabler proposed a framework for categorizing NFT Finance’s products, based on tradFi’s market infrastructure. This categorization is useful not only for understanding the mechanisms of NFT finance, but it offers a general framework for understanding and developing this universe. With that in mind, let’s break them down and see how each category works in practice by exploring a number of innovative platforms already in operation.
- Debt securities: creation of fixed income instruments that generate NFT-based cash flow, such as a peer-to-peer loan for which an NFT is used as collateral.
- Equity-like: creation of any instrument allowing the ownership of fungible elements backed by non-fungible elements, for example the fractional tokenization of NFTs via ERC20s.
- Aggregation-like: the creation of investment vehicles, aggregators or market-making utilities that allow individuals to become market players solely on the basis of initial capital, without any technical knowledge being required – such as index tracker funds or an automated NFT market maker.
The majority of existing “debt-type” products are lending platforms. Borrowers benefit from liquidity without having to sell their assets, while lenders benefit from a profitable APR (annual percentage rate). Transactions are executed via a smart contract and if the borrower defaults, the lender automatically receives the secured NFT – the most commonly listed collections include CryptoPunks, Bored Apes, Art Blocks, and VeeFriends, to name a few!
In the equity-like category, we have seen the rise of NFT-based securitization products that allow the co-ownership of non-fungible items. The Particle Collection, for example, is a pioneer in the collective ownership of first-rate traditional works of art, acquiring paintings that are then subdivided into 10,000 individual NFTs (or particles), which can be collected and exchanged. The first artwork to be particalized was Banksy’s “Love is in the Air,” which was purchased for $12.9 million at auction in 2021. The physical work, as well as all future acquisitions, will be installed in an upcoming non-profit foundation, the Particle Foundation, both physically and in a metaverse museum.
For aggregation-type instruments, indices managed by DAOs are a thriving example. The Cooperative Index, a DAO (decentralized autonomous organization), currently manages more than $400 million in assets, with a variety of crypto-related investment opportunities for individuals and institutions. These investment vehicles are experiencing a sharp increase in demand, with the number of index holders at Index Coop alone increasing from 5,000 to more than 30,000 during 2021.
The value of NFT Finance
NFT Finance is not an accessory to the NFT universe, but will prove fundamental to the mass adoption of NFTs beyond the limited sphere of art and collectibles. As we have pointed out in this article, NFTs have the ability to improve industries, from supply chain management to real estate, and NFT finance opens up new opportunities for participation and profit for individuals and institutions.
Due to the nature of DeFi composability that is unique to blockchain infrastructure (as are NFTs), there is an unprecedented level of interoperability between NFT markets and NFT Finance compared to traditional markets and their respective financialization.
The potential user base of NFT Finance’s products is therefore much wider than in traditional Specialist Finance, with the typically decentralised nature of these new products removing other barriers to entry. If NFTs are at the forefront of integration and mass participation, NFT Finance will be a decisive factor.